Rental Property Tax Question

[Deleted]

We are purchasing a new home and trying to decide if we should sell or rent the old one. With the high HOA, property taxes, and mortgage (higher payment because of 15 year fixed), we'd need to subsidize $1000/mo. If I look at the subsidy amount versus the reduction in principal over 5 years, it is almost break even (come out slightly ahead).. So I'd be betting on appreciation of the property versus investment gains if the house was sold and the $1000 subsidy was invested.. But anyway, that is not my question.

My question is around tax deductions. My wife and I are well over the $150k MAGI cut off, so does that mean that nothing is deductible on a yearly basis? We are not "in the industry", so these would be passive losses. I've never rented out property before, so I'm trying to understand how this works.

-Mark

[mwcpa]

passive losses create a deferal of any losses until you have profits, then the passive losses can offset the profit...
if you "dispose" of the property then all of the passive loss that were not allowed are "freed" up...

[Deleted]

Mar 14, 2011 15:50:39 GMT -5 mwcpa said:

passive losses create a deferal of any losses until you have profits, then the passive losses can offset the profit...
if you "dispose" of the property then all of the passive loss that were not allowed are "freed" up...

What does that mean freed up? If the property is worth less ( it is) than what was paid for it, there would be no taxes owed on the sale anyway - correct? So what can you do with these freed up passive losses?

[rangerj]

A loss from the operations of a rental property is a net operating loss. The loss is allowed to the extent provided (limited) in the current year, and any excess is carried over to future years until it can be used to reduce passive income. That having been said, when the entire interest in the property is disposed of (generally sold) the opereating losses from prior years that were not allowed to be deducted can then be deducted against your other income, that is "freed up" for deduction.

[rangerj]

Added note: If there is a loss on the sale of the property then that capital loss is deducted against capital gains or to the extent allowed if you have a net capital loss in total.

[mwcpa]

ranger.... actually a loss from the sale of rental property would be 1231.....not limited by the general capital loss rules...

mmc... from the IRS

"Generally, you may deduct in full any previously disallowed passive activity loss in the year you dispose of your entire interest in the activity."

In English and simple math....

Have say you have a rental property that you purchased in 2009 and it reports a passive loss of 10K in 2009 that was not allowed...
and in 2010 you have a profit of 4K
4K of the 10K loss from 2009 offsets the 2010 profit and the unused balance of 6K carries to 2011.

Now, in 2011 you sell the property.... if you have a gain or loss on the sale (it does not matter, disposition is the key), the entire 6K carry over from 2010 is used and that loss is fully allowable....

Also, you note that when you converted the property from personal use to rental the FMV was less than the original cost.... be careful of the depreciation rules related to such change... when property is converted from personal to business use the depreciable base is limited to the LESSER of the FMV on the date of conversion or cost.... so, if you paid 500K (including improvements) for a vacation home and then converted it to 100% rental when the value was 300K the depreciable base is 300K.... and do not forget that land is generally not depreciable....

[Deleted]

mwcpa - There is no expectation that an appraisal be done when you convert a property to a rental is there? In other words, could the FMV be determined by the appraised value the county uses for property tax purposes in the year of the conversion?

Just so I'm clear, I would expect passive loses of $12,000/year. Over 5 years that is obviously 60k. Lets say the value of the property is flat, no gain or loss there. I sell the property in year 5. I can then deduct that 60k of passive losses against my income for that year?

-Mark

[commentator]

Mar 15, 2011 10:22:20 GMT -5 @mmc said:

mwcpa - There is no expectation that an appraisal be done when you convert a property to a rental is there? In other words, could the FMV be determined by the appraised value the county uses for property tax purposes in the year of the conversion?

Just so I'm clear, I would expect passive loses of $12,000/year. Over 5 years that is obviously 60k. Lets say the value of the property is flat, no gain or loss there. I sell the property in year 5. I can then deduct that 60k of passive losses against my income for that year?

-Mark

In Virginia the local government real estate appraisals are a year out of date when issued. In today's market I hope that means that my home's current FMV is more than than my county's appraised value.

Yes, when the activity's assets are disposed of, any suspended losses are deductible.

[nancy65]

Mar 15, 2011 10:22:20 GMT -5 @mmc said:

mwcpa - There is no expectation that an appraisal be done when you convert a property to a rental is there? In other words, could the FMV be determined by the appraised value the county uses for property tax purposes in the year of the conversion?

-Mark

I have never lived anywhere that the tax appraised value is a true representation of the Fair Market Value.

It would be easy enough to have a Real Estate Broker give you an estimate of the FMV (remember to separate the land value out of your depreciable property value.)

[Deleted]

Mar 15, 2011 15:44:54 GMT -5 @nancy65 said:

I have never lived anywhere that the tax appraised value is a true representation of the Fair Market Value.

It would be easy enough to have a Real Estate Broker give you an estimate of the FMV (remember to separate the land value out of your depreciable property value.)

I'm looking for what the IRS would accept as proof of FMV. The lagging nature of county assessments could be helpful in this situation.

[mwcpa]

the IRS and other taxing agencies would want a valuation from a reputable source close to the date of conversion.... a county assessment from a year ago is probably not good enough....

[nancy65]

Mar 15, 2011 15:51:38 GMT -5 @mmc said:

Mar 15, 2011 15:44:54 GMT -5 @nancy65 said:

I have never lived anywhere that the tax appraised value is a true representation of the Fair Market Value.

It would be easy enough to have a Real Estate Broker give you an estimate of the FMV (remember to separate the land value out of your depreciable property value.)

I'm looking for what the IRS would accept as proof of FMV. The lagging nature of county assessments could be helpful in this situation.

County assessments are in no way proof of FMV, only of that particular county's assessed value for its own property tax purposes.

[Deleted]

CA's property tax assessments (where the OP's property is located) are based on the salesprice. Each year they are allowed to go up by 2%. Alternatively if the FMV drops below the assessed value one can challenge the assessed value and get a temporary lower assessment. I've done it twice now. It's about the only good way to get a decent appraisal out of the County with respect to a break down between improved and land value. Otherwise they seem to just split the value 50-50.

[rangerj]

Thanks MW. You are correct on the 1231 treatment for the loss, if any. Sorry to the OP. I had a temporary brain freeze. I should not be on this site and eating ice cream. And its only mid-March.

[mwcpa]

ranger... mid march is the worst time of year.... we have march madness, corporate deadlines and the 3rd amended 1099 from a brokerage firm for a client who already filed his tax return all coming at the same time...