If I have a loss on a rental property, and I sell that property and get out of the rental biz, is there a way to claim that loss?

[tagteam]

is there a way to claim that loss?

Yes, it is a Section 1231 loss and is treated as an ordinary loss reported on Form 4797.

You can use the loss to offset all other types of income.

[KimberW]

To add to tagteam's answer: yes, you can generally use an accumulated passive loss to offset non-passive (ordinary) income in the year that you dispose of (sell) the passive activity.

A little more background explanation: Passive activities often generate losses -- particularly rental properties. Rental properties may bring in enough rental income to make for a positive cash flow after paying mortgage, taxes, insurance, etc. but they will show a loss for tax purposes due to depreciation expenses. In some cases, these passive losses can be used in the year that they occur to offset "ordinary" income, such as wages and business income. But the exception that allows for up to $25,000 of passive loss from a rental property to offset ordinary income is limited by adjusted gross income, so it isn't available for everyone and passive losses can build up over time.

The general rule with passive losses is that they can only be used to offset future passive loss income. But, when you dispose of your entire interest in a passive activity (that is, when you "get out of the rental biz"), you are generally able to take all of the suspended losses for that activity that have built up over time. That loss can be used to offset any gain from selling the activity and it can also be used to offset "ordinary" income -- your wages and other business income. [Note: the disposition transaction must be one in which all realized gain or loss is recognized and the person acquiring the interest must not be related to you. So -- installment sales, for instance, won't allow for the entire loss to be taken. A sale to your kid also won't allow the loss to be taken.]

You can find more detail than you ever thought you wanted at the IRS Topic no. 425, Passive activities - Losses and credits, which includes a link to IRS Publication 925, Passive Activity and At-Risk Rules

In TurboTax, you'll tell the software that you are disposing of (selling) the entire activity -- that this is its final year. Make sure you have your carryover information from the prior year return so that you know what the accumulated disallowed loss amount it. The software will then apply the loss against the sale of the activity and your other income as necessary.

Thank you for participating in this event!

-- KimberW

[MauryM]

This is fantastic.  One follow up question.  I've rented this property for the last two years.  Prior to that I lived there over a decade.  I'm hoping to sell before next year to take advantage of the up to $500K cap gains exclusion for primary residences.   With property taxes in TX so high, there is a good chance I will show a rental loss on paper the year I go to sell the home.

If I just enter everything in Turbo Tax, will it be able to sort this out?  I'm not sure if those losses will affect the cost basis of my house or how that will work.  I know I'll need to recapture 2 years of depreciation as well.  I'm just wondering if Turbotax can handle this situation.

[tagteam]

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@MauryM wrote:

I'm just wondering if Turbotax can handle this situation.

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Yes, TurboTax can handle your situation.

You will enter the transaction in the Rental Properties section of the program since the last use of the property was for rental purposes. 

[KimberW]

Yes, TurboTax can handle this situation. If you have already used TurboTax for this rental property, then your prior year information will carry forward automatically for you. If not, make sure that you have the records form your prior year returns for your carry overs, including disallowed losses and accumulated depreciation.

When you do sell the property, you'll need to pay close attention to the questions on the screen. You'll be entering the sale information from the rental property section of the return because that is its current use. You'll tell TurboTax that you have sold the property. It will ask you for the date of the sale and it will ask you if the property has always been 100% business use. If your property is already in TurboTax from a prior year, this should already be filled in for you. Regardless, in this case you'll answer "no" because it wasn't always business use and then you'll fill in the date you converted it to business use.

One of the last questions in the section about the sale of the rental property will be "Was this asset included in the sale of your main home?" Answer "Yes" to this question and TurboTax will step you through the remaining questions to determine how much of the gain from your house can be excluded. It will apply the carryover information correctly and will split the information between the sale of the business asset (reported on Form 4797) and your personal residence (reported on Schedule D, with any appropriate gain exclusion).