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, not all income is subject to tax. The sale of outside property is not taxable in Michigan and is not subject to Michigan state income tax according to this State of Michigan link.

Additional reference:

MI-1040 Instructions (no forms)

[Edited 1/28/2024| 4:30 PST]

[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]

---

@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. 🙂

[DaveF1006]

 It depends.  Sounds like you have some issues on how this is reported in Turbo Tax.  It is difficult to pinpoint the specific issue without looking at your return.

To look at your in detail , we would like to see a diagnostic copy of your return. The information in this file is a sanitized copy meaning there is no personal information, only numbers so that we can examine your return in depth, check for calculation issues, and to see how certain items are applied, especially in form MI-4797. Here is how to order. 

1. For Turbo Tax online, go to tax tools>tools>share my file with agent.  When this is selected, you will receive a token number.  Respond back in this thread and tell us what that token number is. 
2. If you use the desktop version, go to the black stripe at the top of the program, click on online, and then select send tax file to agent. Let us know what the token number is.

[annieland]

Yes @DaveF1006 it does appear there is an issue in TurboTax's handling of the MI-4797 form. You can see the answer I got from the MI Dept of Treasury in this associated more specific thread of mine here. 

Ok, if you think you can help, go for it.  I've just been working on other parts of the return while formulating a plan to file by mail when the time comes. My token:

69119244  13091933

Thanks!  Let me know if you notice the problem.

[DaveF1006]

It depends.  The 100% allocation" is referring to the entire amount of gains or losses associated with the transaction being allocated to you, regardless of any other factors. It also indicates the total amount is allocated to you, but there are adjustments that cause the taxable amount to be zero (for example, offsetting losses, basis adjustments, etc. In this case, the gain is out of state thus will offset the 100% allocation. The 100% allocation appears but is not applied in your return.

Meanwhile, the sale of outside property is not taxable in Michigan and is not subject to Michigan state income tax according to this State of Michigan link.

From looking at your return, it appears that the return was prepared correctly. Your gain was subtracted in schedule 1.  Also your business loss is added back to your Michigan income. This is because of the business activity occurs entirely outside of Michigan. Losses from business activity that occurs entirely outside of Michigan cannot reduce Michigan taxable income and must be added back to AGI. If you compare your Michigan AGI with your federal AGI, the amounts are different due to the addition of the suspended losses.

Please review the following link and look under How is Michigan business income or loss determined in the link provided below.

Michigan Business income

Edited 01/27/24|5:45 pm PST]

@annieland 

[annieland]

Thanks a lot for taking a look for me.  I have spent hours... days even, reading entire chapters of the Michigan tax code and professional preparer documents, as well as finally putting in an inquiry with the state treasury.  Evidentially I've filled it out correctly from the start.  Problem is I had to delete a heck of a lot of stuff in Turbotax to do it, and the 100 still appears there unless I override it, which makes the resulting math on lines 21 & 23 inherently incorrect.  Some draft returns I've prepared, not what I sent you, also randomly throw red errors on the zeros on line 23.  So I'm being very careful to not mess with this return to avoid that starting up again.  

I'm going to have to paper file this in the end.  Is Turbotax interested in having this dysfunction in the MI state software corrected?  I've never talked to technical support so I don't know how that works or if I should bother at this point.