Michigan Resident sold Rental Property in NY - Help with proper allocation

[annieland]

After spending nearly a year researching and estimating the tax implications of finally selling a family rental property I inherited 5 years ago, I think my Federal numbers for 2024 are pretty solid.  The property was professionally appraised within a couple months of inheritance, all new improvements and intangibles were tracked and depreciated or amortized as appropriate for the years owned, and capital gains have been proportioned according to land percentage vs. the structure + each asset.

The primary complication is the extensive suspended loss that is now being claimed.  Due to this having been a very old and expensive house to maintain, and rental income no longer being sufficient to turn a profit in the few years I owned it, the carryover loss outweighs the capital gain I am reporting by over $40,000.  But ok, that finally offsets ordinary income and other non-related carryover losses from prior years and Fed taxes are looking good and as expected.

I just want to make sure I am properly allocating this sale between NY and MI based on my understanding of the tax rules.  I had no tax withheld to NY at closing because I calculated (correctly, I believe) that there was no way I would be liable for a capital gains tax after the original step-up in cost basis plus additional improvements and capture of suspended losses.  A NYS non-resident return has always been filed for this property no matter who owned it at the time and how much income or loss was reported in any given year.  For the past 5 that I owned it, it was always zero and all expenses and rental income was allocated to NY sources and not MI.

So now that all forms and state returns I need are available, I made a fresh dummy return with ONLY the rental sale-related numbers, and when I step through Michigan, for each asset disposal for the MI-4797 form TT pre-populates with Federal gain and recapture to Michigan.  When I edit it to 0., TT reflects that on the MI-4797 form, but keeps the "Percentage of Gain Subject to MI Tax" at 100.00 on line 19.  Therefore, it appears I am incorrectly multiplying the gains by 0 instead of allocating all at 100%.  Everything else appears to be correct as far as how MI treats out-of-state rentals (as business income and losses) on their Schedule 1 of additions and subtractions, and my MI AGI (when adding W-2 income in another dummy return) does show a larger number than Federal.  I'm just nervous that the appearance of a self-entered 0 against a TT-filled 100 on the same form as submitted won't support a $0 capital gains tax owed to MI (and NY as well).

Praying someone with some Michigan Income Tax knowledge will show up to alert me to any errors I or TurboTax (Desktop, Mac) is making!  I attached a pic of a portion of the MI-4797 I'm referring to. Thanks so much 🙂 

[AmyC]

1. I see a gain, not a loss. Your suspended loss should be included to remove the gain.

2. As a MI resident, all income is subject to tax. MI will give you a credit for tax paid on the same income to NY. Enter the NY return first. Then enter MI and the rental income at 100% taxable to MI. You are not double taxed.

Your MI 1040 line 18 shows tax paid to nonreciprocal states.

3. Your attachment shows line 19 100% taxable to MI but everything below that looks wrong, it should be showing your MI taxable income.

See page 10 Line 18 instructions for how the double tax is eliminated at MI-1040 Instructions (no forms)

[annieland]

Thank you SO much for replying.  If I do it your way I get a big refund from MI based on my much lower Federal AGI because of the suspended loss offsetting gains and reducing ordinary taxable income.  Because of that I have no tax liability in NY for MI to credit me for, or otherwise.  

Perhaps my error is that on the MI Schedule 1 I have my recaptured loss (123k) in the 2nd line in the box and on Line 4 because it is a deduction to my Fed AGI due to a property sale located entirely out of state and I am a full-year MI resident.  The MI tax preparer instructions state: "A Michigan resident may subtract from AGI income that is not allocated or apportioned to Michigan. Conversely, losses not allocated or apportioned to Michigan must be added to AGI."  But I am not a business because this is not considered MI business income because it doesn't "constitute[s] integral parts of the person's regular trade or business operations." 

Therefore on my Schedule 1 I added back the $123k loss and then subtracted the $76k gain because every MI tax code and preparer manual I read says income from a sale of a property out of state should not be allocated to Michigan unless it's business income and I'm not a business.  Perhaps it is because that box on the Sch 1 is for business income I shouldn't put it there even though it is a loss out of state?  I feel like it's wrong to take advantage of the big reduction in Federal AGI in MI when that's the whole reason we have the list of required MI additions to income.

So then you're saying my Michigan AGI should match my Federal with no reference to a loss from another state and my Sch 1 should only show the NY gain added and then subtracted netting $0 and AGI unchanged.  If that's the case, I'm getting a lot of W-2 withholdings back from MI which makes me nervous.

[annieland]

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@AmyC wrote:

2. As a MI resident, all income is subject to tax. MI will give you a credit for tax paid on the same income to NY. Enter the NY return first. Then enter MI and the rental income at 100% taxable to MI. You are not double taxed.

Hey again.  I just attached what TurboTax provides in the in-app help for the MI-4797 form and highlighted what appears relevant to my situation.  The last paragraph is why I changed those gains to 0 for Michigan and why I didn't feel like it should be taxable at all to MI regardless of a credit I may or may not receive for NY. And since my NY taxable income is $0 after deducting the reclaimed passive loss there is no tax owed to NY to credit back to MI.

Sale of non-Michigan rental real estate: If the gain from sale of rental

real estate from outside Michigan is included in line 21 or 23, it is not

subject to Michigan tax. Modify the gain calculated to reflect the gain

taxable to Michigan.

Does this conflict with what you're saying vs. how my MI-4797 was filled out with all the 0's above? 

Thank you! I'm getting so confused here and I really, REALLY want to figure this out on my own. 🙂