Our house has nowhere near the value of its purchase price. We live 2000 miles from it and have rented it out before, though right now I’m living in it for the next few months.
Is our best case scenario (tax-wise) to get renters into it and then sell it at a loss to them so we can write off the inevitable loss?
Well, it’s comforting to know that 130 other people are interested enough to know the answer.
A more descriptive title probably would have helped the effort to get an answer.
Point taken as this is GQ, but almost the entire post shows up in mouseover on the title.
Wouldn’t your best-case scenario be to rent it out for an amount equal to mortgage payments + property tax, and then sell it when it has increased in value?
I’ve edited the title to perhaps attract people who might know.
Pardon my lack of information in the OP; the market in our area has dropped considerably in the last several years and there is a glut of rentals keeping prices lower than our monthly mortgage payments. I spend so much time going over this problem in my head I forget it won’t all come out in what I wrote.
I think I understand your question, but let me restate a bit. You bought a house for $100, you think it’s worth $60, and you want to sell it eventually, so you’ve accepted the fact that you’ll lock in a $40 loss. If you don’t rent it out, then the loss isn’t usable for tax purposes because it’s just a personal loss. You are asking whether the loss is usable for tax purposes if you rent it out before you sell it.
The answer is: maybe. 
The passive loss rules (Code section 469) provide that losses from passive activities (which includes renting real estate) are usable only against gains from passive activities. Buying and selling stocks and earning interest are not passive activities for this purpose. So, if you have $40 of income from selling other real estate (or other passive activities, such as from owning interests in partnerships where you are a limited partner), then that would be a currently usable loss. Otherwise, it wouldn’t be usable now (but should be usable in the future if you get some passive income).
I’m a lawyer but not yours, the above could be wrong, I’ve had a couple of beers, have a nice day and bob’s your uncle.
I had money invested in a real estate development, because of the down turn the banks would not lend any more money (construction loan) and demanded payments for the loans outstanding. If you can not finish building the project you can not sell units. No income no paymnents. The bank forclosed on the property and we lost our investment.
According to my CPA if I have not capitol gains I can only deduct $3,000 a year as a capitol gains loss. That means for the next 20+ years I get to take the loss. Hopw I live to be 83.
On a practical basis of you are that far away from the house your best bet is to dump it for a loss. If you were closer you could do a rent to own scenario or something creative, but 2000 miles away puts a crimp in how attentive you can be to how it’s being taken care of.
Having said this eventually the market will recover, but if you have to rent it at a loss vs selling it at a loss in the interim I’d prefer the guillotine than the death of a thousand cuts if you can take the hit.
Thank you, you answered some of the most important part of what I worry about and I’ll look more into that Code as well. I feel like I need to write myself a brief.
Ugh, I’m sorry to hear about that Snnipe, that’s horrible. I don’t know anyone whose money grows on trees. I hope you live to be more than 83, btw, just because.
This has been my exact thought process for several months, but I’ve lately been hearing positive stories from landlords who’ve vetted their tenants very thoroughly. The loss on selling a primary residence can’t (as far as I’ve been told by our tax pro and backed up by the IRS website) be written off but the losses on a rental can. I want to be hopeful, it would feel so much better than this cloud of fear and cynicism that’s been hanging over us.
If you start renting the house at a loss, you may be able to deduct all or a portion of the loss in the current year, and the remained in a future year. Note that Internal Revenue Code Section 280A limits rental losses in certain circumstances (e.g. if you rent to a related party, below fair rental value). But let’s assume 280A doesn’t apply.
As Rand Rover mentioned, rental loss is passive, and cannot be deducted against active or investment income. You’d be able to use the rental losses to offset any passive income (e.g. from partnerships, S-Corps) in the current year. If you don’t have enough passive income to offset all your losses this year, you can carry your unused losses to future years. All of your carry-forward loss can be taken in the year when you sell the property.
There is also a Special Loss Allowance of up to $25,000 for rental losses. In other words, you can deduct rental losses of that amount in the current year, even if you don’t have passive income. To take this allowance, you have to actively participate in renting the property. The requirements of active participation are relatively easy to meet. Basically, you just need to show that you’re doing some actual work when it comes to the rental activity, instead of having someone else take care of it. Even if you hire a management firm to help you rent the property, you may be considered “active” if you make major decisions (e.g. select tenants, approve repairs, etc).
The $25,000 special allowance is reduced once your modified adjusted gross income (MAGI) is more than $100,000. It’s fully phased out once your MAGI is more than $150,000.
Let’s say you rent the property for a while, and then sell it. First of all, as already mentioned, you can deduct all of your suspended rental losses. Second, you can take a loss on the sale. But, here’s where you have to be careful. Your basis in the property will be the fair market value of the property on the date when you converted it from personal to rental, less any depreciation you deducted (or could have deducted) while you rented it, plus any capital improvements. In other words, your original costs basis (how much you paid for the house when you bought it) is not part of the equation anymore. As a result, you may end up with a gain.
[Insert all usual disclaimers about tax advice.]
Excellent and understandable advice, ok11, thank you! That all made sense to me.
My experience.
In 1987 I bought a co-op apartment in Queens New York for $105,000.00. Then the crash came. Around 92 I moved out of the apartment and rented it out. At the time I valued the apartment at $60,000.00 for the purposes of depreciation. In fact, it was not possible to sell my apartment for anything near that (foreclosed apartments in my building went for less than $10,000) I had a loss on the rental itself and I used the depreciation to increase the loss I was able to take on the rental. I was fortunate and I had good renters. I finally sold around 2002 for around $80,000.00.
In that year I had to capital gains on the $20,000.00 (remember, I actually lost $25,000) because of the difference between what I had valued it when I put it into service and what I sold it for. I also had to add back all the depreciation into that year’s income and pay regular income tax on it (not capital gains). Fortunately I was doing well enough to take that hit, but it was not a pleasant year.