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Visitor II

Rental Property Loss After Conversion Back to Primary Residence?

My parents had a rental home for several years that they rented out while living in their primary residence.  Last year they sold their primary residence and moved into the rental property.  They are considering selling this rental property / current primary residence and have heard somewhere that they can claim the loss on their rental property for up to 5 years after converting it back to a primary residence.  I cannot find any information to support this.  Does anyone know if this is possible?

1 Comment
Catalyst V

Rental Property Loss After Conversion Back to Primary Residence?

I seriously doubt they will sell at a loss.

For starters, since the owner of the property will be the last one to move out of the property prior to the sale, the sale can not be reported in the rental/royalty income (SCH E) section of the program, or the Sale of Home (Gain or Loss) section of the program. The program will not "do the math" correctly for this specific situation of reported in either of those sections.

The sale must be reported in the Sale of Business Property section of the program.

Now, they will not qualify for the capital gains tax exclusion on any gain from the property, because it was not their primary residence for at least 2 of the last 5 years they owned it. But even if the live in the property as their primary residence for 2 years before selling it, they will still pay taxes resulting from the sale.

This is because all prior depreciation taken on the property while it was classified as a rental, has to be recaptured in the year the property is sold. Taxes *will* be paid on that recaptured depreciation at a minimum tax rate of 15%. The only way to not pay taxes on the recaptured depreciation, is to sell the property for less than it's adjusted cost basis determined in the year of the sale. For example;

Say the property was purchased for $50,000 and during the time it was rented out they took $$10,000 of depreciation on it.  In the year of sale the cost basis will be the $50K paid for the property, minus the $10K of depreciation giving an adjusted cost basis of $40K. So if the property is sold for more than $40K then tax *will* be paid on the amount over $40K.

Losses will be allowed from ordinary income in the year of the sale *IF* there are *in fact* any losses. There may not be after the recapture of depreciation. However, in order for the program to "do it right" the sale must be reported in the Sale of Business Property section of the program.