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William Perez

Loss on Sale of House: Any Options I Have?

By March 20, 2006

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Today's tax question comes from Paul in North Carolina. He asks, "I am trying to determine whether my circumstances are worth pursuing or not. I bought a house in December 2001 in Michigan due to a new job. In February 2004, I changed employers again, and I purchased a home in North Carolina in May 2004. I put my Michigan home up for sale in February 2004, and also tried to rent it out from May 2004 because the house wasn't selling. I was not able to rent the home, but I finally sold the home in March 2005. As the home was no longer my primary residence, and I did attempt to rent the home and was unable to, will the IRS allow me to take a $55K capital loss on the home? The housing market dropped due to a massive layoff and rentals were not needed in the area. I know it is a stretch, but what are the chances of it being accepted by the IRS? It was a valuable learning experience to not buy a unique house for the area, not to buy before selling the first house, and that capital losses on owning a home are not tax deductible. I am looking at paying $4700 instead of getting back $550."

You have a number of serious tax issues. I urge you to seek the help of a tax professional right away. Make sure you find a tax preparer who is experienced with reporting the sale of a home and rental real estate issues.

Let's cover some basics. You will pay capital gains tax on the sale of your home, unless you meet the criteria to exclude some or all of your gains. Now, you sold your house because the location of your job changed, so it might be possible to take a partial exclusion.

However, it sounds like you lost money on your house. That means you have no gain or profit to exclude, since you actually lost money on the sale.

If you sold your house for a loss, that loss is not tax-deductible if the house was your personal residence. The loss might be tax-deductible if the house was a rental property. However, you might have a hard time proving the house was really available to rent. A reasonable question an IRS auditor might ask would be, "who would rent the house knowing that the house is up for sale and they would have to vacate when the new owners take possession of the house?" Thus you might need to produce backup documentation, like classified ads for the rental, or a contract you signed with a property management firm to manage the property on your behalf.

Another crucial factor, this is now the year 2006, and you are working on your 2005 tax return. The period of time we are talking about covers 2004 and 2005. Did you report the house as a rental property on your 2004 tax return? If you try to report the loss as rental property, an IRS auditor would ask the obvious question: did you report the rental income and expense on your 2004 return. If you did not, the auditor would suspect you are trying to convert a non-deductible loss into a deductible loss, and they would probably would expand the audit to cover two years in order to figure out if the house was really a rental property.

Also, the formula for calculating gains or losses on rental property is slightly different than the formula for calculating gain or loss on a personal residence. I provide the rental property formula in my article on Rental Income and Expenses.

If you do decide that the house was a rental property, you will need to correct your 2004 tax return to accurately report your rental expenses. You will do this by filing an amended tax return. You will then need to accurately calculate your gain or loss in 2005. Sales of rental property are reported on Form 4797 instead of Schedule D.

One final word of caution: you give two figures for a tax refund or balance due. It is highly likely that neither number is accurate. You will need to hire a tax professional to thoroughly review your 2004 and 2005 taxes and determine the best way to handle the sale of your house in Michigan.

PS when reviewing your 2004 return, make sure you took a tax deduction for any moving expenses you paid for.

Throughout the tax season I will be answering one tax question per day. Do you have a question? Visit the Ask a Tax Question page. Disagree with my answers? Post your comments in the Tax Forum.

February 25, 2010 at 2:59 pm
(1) elizabeth says:

Note: If the house is converted to a rental the basis is the lower of the adjusted basis or Fair Market Value as of the date of conversion. Therefore the loss in value while the house was a personal residence is not allowed as a part of the calculation of the loss. You may not even have a loss from what I am seeing!

June 26, 2011 at 11:31 am
(2) Howard Barnett says:

elizabeth: Is the basis of the converted rental really the lower of adjusted basis or Fair Market Value on date of conversion or is the Fair Market Value on date of conversion (plus any improvements etc)? I’ve been told when you convert a rental it’s Fair Market Value on date of conversion (plus improvements if any of course) and you’re original purchase price and improvements are not the basis.

June 23, 2011 at 3:22 pm
(3) Kenny Chang says:

Quick question, what if the house wasn’t your primary residence and you lived overseas ever since you bought the house. The house was just bought for the parents. At the time the house was bought at $600,000 but now selling for $500,000. So it will be $100,000 loss. Since the owner never lived here is their a way to claim some kind of loss on the taxes?

May 7, 2012 at 11:55 am
(4) John says:

Maybe you can carry the capital loss forward to offset your capital gains.

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