Tax Treatment of Loss on Condo Sale


J

JB

What is the tax treatment on a loss from the sale of a rental condo?

We purchased a condo in January 2006 for my son to use while in college.
After he graduated in 2009, we converted the property to a rental and have
been renting it out for the last three years. We are now in process of
selling the condo at a huge loss with a closing date of August 1, 2012.
That's also the date our tenant will be moving out. We are selling the unit
for $85,000, some $70,000 less than what we paid for it.

At the start of the rental in 2009, we assumed the basis of the property to
be $156,697. For tax years 2009 through projected 2012, our total
depreciation expense will be approximately $18,282. Subtracting out the
depreciation and the selling price, our net loss will be roughly $53,415.
Is this loss treated like any other capital loss? That is, if all our other
capital gains net out to zero each year, will we be taking this as a $3000
annual tax reduction for the next 17+ years?
 
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M

Mark Bole

What is the tax treatment on a loss from the sale of a rental condo?

We purchased a condo in January 2006 for my son to use while in college.
After he graduated in 2009, we converted the property to a rental and
have been renting it out for the last three years. We are now in process
of selling the condo at a huge loss with a closing date of August 1,
2012. That's also the date our tenant will be moving out. We are selling
the unit for $85,000, some $70,000 less than what we paid for it.

At the start of the rental in 2009, we assumed the basis of the property
to be $156,697.

If I follow your math correctly, you used your adjusted basis as the
basis for depreciation. You should have used the lower of fair market
value (FMV) or adjusted basis. Just looking at the dates involved,
without knowing the exact real estate market, it is unlikely that your
basis for depreciation was lower than FMV, indeed it is highly likely
that FMV was much lower.

The loss in value you undoubtedly experienced from 2006 to 2009 was
personal loss and is non-deductible for tax purposes.


For tax years 2009 through projected 2012, our total
depreciation expense will be approximately $18,282. Subtracting out the
depreciation and the selling price, our net loss will be roughly
$53,415. Is this loss treated like any other capital loss? That is, if
all our other capital gains net out to zero each year, will we be taking
this as a $3000 annual tax reduction for the next 17+ years?
Give my comment above, it is likely that your loss on sale of the rental
is actually much smaller than you are estimating. You cannot convert
the non-deductible loss from the period of personal use to a deductible
loss on rental real estate.

Otherwise, your comment is correct, only $3K of capital loss can be used
each year to offset other ordinary income.
 
J

JB

Mark Bole said:
If I follow your math correctly, you used your adjusted basis as the basis
for depreciation. You should have used the lower of fair market value
(FMV) or adjusted basis. Just looking at the dates involved, without
knowing the exact real estate market, it is unlikely that your basis for
depreciation was lower than FMV, indeed it is highly likely that FMV was
much lower.

The loss in value you undoubtedly experienced from 2006 to 2009 was
personal loss and is non-deductible for tax purposes.
You raise an interesting point about the depreciation basis, and it was an
issue we considered when we put the unit into service as a rental. Since
our unit had not been appraised since we originally bought it, we decided to
look at comparable sales in the area to determine if the original adjusted
basis was a valid number to use for fmv. It turns out that no other units
in the building had sold during the prior two years (it is a relatively
small building with fewer than 30 units). So I got a listing from the
property appraisal site for the county of all the condos that had sold in
the zipcode during the six months prior to the conversion, and I filtered
the list to include only condos that were the same number of bedrooms and
the same approximate age as our building (which was relatively new).

It turned out that in the six months prior to the conversion, there were
seven such sales and the average selling price was 163,300. While all seven
were larger than our unit in total square footage, they were the only one
bedroom units sold during this time period which were a similar age to our
unit. Interestingly, the one unit that was closest to us in square footage
(only slightly larger than ours) and which coincidentally had sold during
the same month as our conversion, sold for $210,000. On the basis of all
this, we decided we had sufficient documentation to use our original
adjusted basis as the approximate fmv for the depreciation basis.
 
R

Rick

JB said:
You raise an interesting point about the depreciation basis, and it was an
issue we considered when we put the unit into service as a rental. Since
our unit had not been appraised since we originally bought it, we decided
to look at comparable sales in the area to determine if the original
adjusted basis was a valid number to use for fmv. It turns out that no
other units in the building had sold during the prior two years (it is a
relatively small building with fewer than 30 units). So I got a listing
from the property appraisal site for the county of all the condos that had
sold in the zipcode during the six months prior to the conversion, and I
filtered the list to include only condos that were the same number of
bedrooms and the same approximate age as our building (which was
relatively new).

It turned out that in the six months prior to the conversion, there were
seven such sales and the average selling price was 163,300. While all
seven were larger than our unit in total square footage, they were the
only one bedroom units sold during this time period which were a similar
age to our unit. Interestingly, the one unit that was closest to us in
square footage (only slightly larger than ours) and which coincidentally
had sold during the same month as our conversion, sold for $210,000. On
the basis of all this, we decided we had sufficient documentation to use
our original adjusted basis as the approximate fmv for the depreciation
basis.
As a practical matter, is it even likely the IRS would challenge the
depreciation basis after it had been recorded on the return for the prior
three years (since 2009)? A $70,000 loss on the sale of property after
three years isn't all that unusual - I know many people who have lost a lot
more than that.

And in this particular case, is there any reason the IRS would question the
taxpayer's documentation of how he calculated the FMV?
 
J

JoeTaxpayer

As a practical matter, is it even likely the IRS would challenge the
depreciation basis after it had been recorded on the return for the
prior three years (since 2009)? A $70,000 loss on the sale of property
after three years isn't all that unusual - I know many people who have
lost a lot more than that.

And in this particular case, is there any reason the IRS would question
the taxpayer's documentation of how he calculated the FMV?
As with most situations, it's a question of (a) does this situation
trigger and audit and (b) if audited for whatever reason, is this
situation legit?

If we're to look at this scenario, I think the situation won't trigger
the audit, but when they dig and see depreciation on the wrong starting
numbers, the OP going to show his math.
I also think it's our job to point out the correct answers, and if
something is wrong, to suggest it be make right. This may mean 3 years
amended returns.
 
R

Rick

JoeTaxpayer said:
As with most situations, it's a question of (a) does this situation
trigger and audit and (b) if audited for whatever reason, is this
situation legit?

If we're to look at this scenario, I think the situation won't trigger the
audit, but when they dig and see depreciation on the wrong starting
numbers, the OP going to show his math.
I also think it's our job to point out the correct answers, and if
something is wrong, to suggest it be make right. This may mean 3 years
amended returns.

But in this case the taxpayer has a rationale for how he came up with the
FMV for the start of the rental, using statistics on comparable sales in the
area. Is the IRS really likely to challenge his FMV calculation? What
else would the IRS expect the owner/landlord to do in this situation, if no
other units in the building had recently sold? I would think that if the
owner follows a logical, rational process to calculate the FMV using data
from the county government, the IRS would probably give him the benefit of
the doubt.
 
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J

JoeTaxpayer

But in this case the taxpayer has a rationale for how he came up with
the FMV for the start of the rental, using statistics on comparable
sales in the area. Is the IRS really likely to challenge his FMV
calculation? What else would the IRS expect the owner/landlord to do
in this situation, if no other units in the building had recently
sold? I would think that if the owner follows a logical, rational
process to calculate the FMV using data from the county government, the
IRS would probably give him the benefit of the doubt.
Sorry, I jumped in at the point where it seemed he started at a
valuation higher than it should have been. If not, my bad.
 
M

Mark Bole

But in this case the taxpayer has a rationale for how he came up with
the FMV for the start of the rental, using statistics on comparable
sales in the area. Is the IRS really likely to challenge his FMV
calculation? What else would the IRS expect the owner/landlord to do in
this situation, if no other units in the building had recently sold? I
would think that if the owner follows a logical, rational process to
calculate the FMV using data from the county government, the IRS would
probably give him the benefit of the doubt.
Hopefully our answers in this newsgroup go beyond just what the odds of
winning "audit roulette" might be.
What else would the IRS expect the owner/landlord to do in
this situation,
Answer: get a professional appraisal.

I am not a professional appraiser, but of those appraisals I have seen,
comparable properties are selected using more attributes than just zip
code and number of bedrooms (if it was that simple, why would anyone
ever hire a professional appraiser?) OP cites an average price, what
was the median? OP says every one of the properties that he compared to
were larger than his, but he made no adjustment for that. Also, I think
it's common knowledge that property values depend heavily on items such
as quality of school district, proximity to public transportation,
whether the property is on a quiet residential street or in a busy
commercial district, the available views from the unit, what the condo
HOA fees and common amenities are (parking, pool, security), and so on.
I would expect his amateur appraisal to take note of those factors as
well.

It might be helpful in terms of this newsgroup discussion to provide the
county where the property is located. If the overall real estate
valuation in that county followed the pattern of the rest of the
country, what extraordinary factors caused this particular property to
go contrary to the trend -- retaining its value from 2006-2009 when
everyone else was going down the tubes, and then somehow losing almost
45% value from 2009-2012 when everyone else was stabilizing or recovering?

Not a tax question, but from a financial viewpoint, I wonder what the OP
was thinking when converting to a rental -- if the evidence was such
that they could sell the property and break even in 2009, why not take
advantage of that good fortune?
 
M

Mark Bole

I also think it's our job to point out the correct answers, and if
something is wrong, to suggest it be make right. This may mean 3 years
amended returns.
Agreed.
 
J

JB

What else would the IRS expect the owner/landlord to do in
Answer: get a professional appraisal.
That might be a good suggestion in hindsight, but at the time we didn't
think it was worth the cost and effort to hire an appraiser just so we could
come up with a better estimate of FMV on our taxes. Our thought was that
since the average sale price of comparable properties was actually higher
than our original basis, it was safe to use the original basis as the FMV
for depreciation purposes.
I am not a professional appraiser, but of those appraisals I have seen,
comparable properties are selected using more attributes than just zip
code and number of bedrooms (if it was that simple, why would anyone ever
hire a professional appraiser?)
The reason I would pay to hire a professional appraiser would be if I am
buying or selling property and want to get an accurate assessment of its
value. As someone who does not rent out property on a regular basis (this
was the only time we ever did it), I didn't see the need to pay for an
appraiser just to improve upon an estimate of FMV for a depreciation/loss
calculation. If I rented out a lot of property or did this for a living, I
might and probably would feel differently.

<< OP cites an average price, what was the median?

The median was 155,500, virtually the same price we used for the FMV.

<< OP says every one of the properties that he compared to were larger than
his, but he made no adjustment for that.>>

Correct. When I looked at the data, there was no correlation between size
of unit and square footage. In fact, the smallest unit in square footage
sold for the largest amount. The fact that all of the units were larger
was indeed an issue, but remember there were only six sales of comparably
aged one-bedroom units during the period in question.
Also, I think it's common knowledge that property values depend heavily on
items such as quality of school district, proximity to public
transportation, whether the property is on a quiet residential street or
in a busy commercial district, the available views from the unit, what the
condo HOA fees and common amenities are (parking, pool, security), and so
on. I would expect his amateur appraisal to take note of those factors as
well.
Those are all valid points, but in this case the sale prices for the six
units were all roughly the same or very close to ours except for the one
that was over 200K and which oddly was closest to us in square footage.

I should mention that our condo was unusual for its location in that it was
a small one-bedroom unit in a building that was brand new when we bought it
(and only three years old when we rented it). The vast majority of condos
in the area were two bedroom units in buildings that were 20-30 or more
years old. When I looked at comparable sales for the prior six months of
one-bedroom condos in buildings that were 3 to 4 years old like ours, I only
got these six results. When I searched for sales of one-bedroom units that
were the same approximate square footage as ours in comparably aged
buildings, there were none. When I expanded that search to include
buildings that were up to five years older than ours, I only found three
comparable sales and they also averaged out to approximately the same number
we used.

But there's no point in getting into the weeds on this. My original post
was not to ask if we could have improved on the FMV, it was to ask if the
loss on the sale (whatever the amount) would be treated like any other
capital loss. And more specifically I asked if all my other capital
gains/losses netted out to zero each year, would I literally have to take
this loss over a 17+ year period taking the maximum $3000 loss each year. I
think the answer I saw from one respondent was yes, this is treated just
like any other capital loss. That's really all I was trying to get from
posting here. The discussion on FMV is interesting, but three or four years
after the fact, I don't really see how I can improve on that number now.
Not a tax question, but from a financial viewpoint, I wonder what the OP
was thinking when converting to a rental -- if the evidence was such that
they could sell the property and break even in 2009, why not take
advantage of that good fortune?
It wasn't a financial decision per se. We held onto the unit because our
son thought he might eventually want to move back in to attend graduate
school, and might even eventually want to buy the unit. That didn't turn
out to be the case. From a strict financial view point, we might actually
be better off holding onto the unit and hoping it goes up in value, since we
make enough money in rent to more than cover our expenses. But we are
selling now because we just don't want the hassle of being landlords any
more. As I said earlier, we don't do this for a living.
 
S

Stuart A. Bronstein

JB said:
That might be a good suggestion in hindsight, but at the time we
didn't think it was worth the cost and effort to hire an
appraiser just so we could come up with a better estimate of FMV
on our taxes.
The IRS is more likely to accept the opinion of a professional
appraiser, though they don't always.

In your case it is possible to get an appraisal of a value on a
specific date in the past, even if you did not get it at the time.
Contact a qualified appraiser for more details.

___
Stu
http://DownToEarthLawyer.com
 
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M

Mark Bole

But there's no point in getting into the weeds on this. My original post
was not to ask if we could have improved on the FMV, it was to ask if
the loss on the sale (whatever the amount) would be treated like any
other capital loss. And more specifically I asked if all my other
capital gains/losses netted out to zero each year, would I literally
have to take this loss over a 17+ year period taking the maximum $3000
loss each year. I think the answer I saw from one respondent was yes,
this is treated just like any other capital loss. That's really all I
was trying to get from posting here. The discussion on FMV is
interesting, but three or four years after the fact, I don't really see
how I can improve on that number now.

The "one respondent" who answered was me. I do try to actually answer
the OP question in this forum before going off on other tangents. ;-)

I appreciate your willingness to share the other information. As a paid
preparer, I was thinking through how I would handle this if you
approached me to do your return, and I hope it was clear I was playing
devil's advocate (due diligence) toward your data. It (the rental
basis) is a problem that for many decades would have never arisen, as a
significant drop in real estate values is a situation I believe most of
us have not experienced until the most recent 4-5 year period. The need
to determine FMV without an actual sale used to be a problem only for
those who inherited real estate and wanted to know the stepped up (or
down) basis.

As you continue to claim your capital loss carryover each year against
ordinary income, be sure to keep all records related to your valuation.
Although I don't think it likely, the IRS can audit the original claim
of a capital loss well beyond the 3-year statute of limitations if you
are still claiming the carryover on current returns.
 

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