PAL in Year of Sale (Rental Property)

[Josh123]

I own a single rental property (only passive activity) that has accumulated a PAL over the last several years and was sold at a loss for tax purposes. Property was fully sold, to an unrelated party, etc. As such, I believe that this PAL can be used to offset ordinary income. 

1. Is this a true assumption?

2. If I were tell sell equity investments for capital gains in the same year, would the PAL first apply to capital gains (lower tax rate) and then to ordinary income? In other words, should I wait to sell stocks at a gain to ensure the PAL offset is to ordinary income?

[Carl]

1. Is this a true assumption?

Yes. Here's how it works with the sale of rental property. (gain or loss) There's two ways to figure this, depending on if you sold at a gain or or loss.

If sold at a gain,  your cost basis is set by subtracting all depreciation from what you paid for the property to get your adjusted cost basis. Then if your sale price exceeds that adjusted cost basis you have a taxable gain.

If sold at a loss, all prior depreciation is added to your sales price. If the total is more than what you paid for the property, that results in a gain then it's taxed as such. If it's a loss, then your losses are deductible from "other" ordinary income. In many situations your allowed loss against other ordinary income may be limited to a maxiumu of $3000 a year until all the losses are used up.

2. If I were tell sell equity investments for capital gains in the same year, would the PAL first apply to capital gains (lower tax rate) and then to ordinary income? In other words, should I wait to sell stocks at a gain to ensure the PAL offset is to ordinary income?

I'm honestly not 100% sure on this, as I don't know for a fact that gains on other investments (which are also passive income) are considered "other ordinary income" for your specific situation. I also don't think losses on the sale of rental property can be used to offset gains on other investment income, since your equity  investment income is not "like-kind" to the rental property investment that you sold.

[mellish7777]

Losses on sales of rental properties and the included released PALs are ordinary losses and offset ordinary income and also capital gains but the LT capital gains tax is calculated differently and separately from the ordinary rate. If your all of your ordinary income is offset by your rental loss then your capital gains are offset by any leftover loss......it doesn't matter that capital gains and rental sale losses are not "like-kind" and that's even used in the wrong context here. You're also not limited to a loss of $3000/year as that's a capital loss limitation and there's no such limitation for ordinary losses. I also don't know what the other person is talking about when he said gains on other investments are also passive income because they're not....those gains are called "capital gains" and they're not "passive" as in gains from a "passive activity".......just because you don't have to do anything to earn gains on investments doesn't make them "passive" for purposes of the tax law.

[Josh123]

Thank you and got it - so net passive losses from sale of real estate (in year of sale) and legacy PALs offset ordinary income (W-2) first and then move onto capital gains (from stock sales) after that? I obviously want to ensure that the passive losses offset the highest tax burden (ordinary income). Based on your response, it seems like there is no reason to delay selling stocks for a gain as the passive loss with offset W-2 income first, correct?

[mellish7777]

You're correct but don't forget that long term cap gains are taxed at 0 percent, 15 percent and 20 percent depending on your income and that would be lower than your ordinary income tax rate. But short term gains are taxed at your ordinary income tax rate so the order makes no difference for net short term gains.

[Critter-3]

The carried over PAL will be reported on the Sch E in the year of sale ... look for the entry on that form.  Then follow the bouncing ball to see how that affects the rest of the return.