Passive Income (Rental) after property is sold

[nash123456]

Hello all,

We have a situation where our tenant owes us $20k in back rent during the time they rented our condo. We finally had them move out this month. We will sell the condo this or next month. We also had the tenant sign an agreement to pay down what they owe in 2024.  We do not have an LLC for this transaction, just regular landlords.  Our carry-over unallowed losses line over the years for this condo shows up as $17,380 on Form 8582. 

My question is, how do we report this future passive income (backpayment) after we sold the condo?  Is there an "other passive income" option when filling out the schedules, or do we need to somehow tie this income to the condo that we owned and rented out? I want to make sure that we do not get flagged for claiming the passive losses in future years (we do not / possibly will not have passive gains to offset these losses) as we are hopefully getting paid for this back rent.  I keep hearing about bad debt but I am not sure if this qualifies for that. 

To add, we'll be selling this condo at a $30k loss (compared to the sale price), which is going to be another topic fo passive losses I suppose? Is that another item that needs to be handled separately from above?

Thanks. 

[tagteam]

Are you going to be selling the condo next year (2024) as well as receiving the (past due) income?

If so, the loss will more than offset your rental income.

[nash123456]

Thank you that’s a great point. We do not know if the closing will happen shortly in 2023 or in 2024. The buyer is extremely interested and is pushing for a 2023 closing. It may help to push it to 2024 to help with this.

However I doubt we will be able to recoup the back rent from the tenants in 2024 alone though, so I’m thinking we’ll have to deal with this scenario in 2025 also. 

Regardless of when this sale happens, the back rent will still be paid to me after the sale of the condo. How does TurboTax deal with this? I am sure it will ask for the date of sale, but it won’t ask the dates that I received the back rent in 2024 so if all transactions are done in 2024 then it may not matter. But if I still receive back rent payment in 2025 it may be an issue?

[tagteam]

If the sale happens in the same year as the past due payment, there will be no issue whatsoever, but is the condo still available for rent?

[nash123456]

Thank you for your reply, no the condo is not and will not be available for rent - we’re dead set on selling unless something goes terribly wrong. 

[tagteam]

Understood, but note that if/when you sell and incur a loss, that loss will not be a passive loss (losses on the sale of residential real estate are nonpassive). As a result, unless you have other passive losses, it makes no difference how the past due rental payment is characterized; you can use the loss on the sale to offset that income.

[nash123456]

Thank you, this is very helpful. So help me understand:

https://turbotax.intuit.com/tax-tips/rental-property/selling-rental-real-estate-at-a-loss/L2RKgClm4

Based on this article, and what I clipped below:

I have as of now $17k of passive activity losses (PALs).  I could only deduct those with passive income if I had any after the sale. But in my case, if I sell at a loss of $30k (is this now a Section 1231 sale?), this does not constitute a passive loss but it can be applied towards the rental income that I may receive in 2024. Did I get this right? But the passive losses will still be carried through the years until we use them all?

"Deducting passive activity losses

If your rental property has generated losses in past years, you might have suspended passive activity losses (PALs). You can generally deduct these passive losses only against passive income, which can be from other activities such as rentals or other passive business activities.

Fortunately, you can also deduct suspended PALs when you sell the property that generated them. If you sell a rental property with suspended PALs, you may be able to deduct them on top of deducting any Section 1231 loss from the sale. Like Section 1231 losses, deductible PALs can offset other income and also create or increase an NOL that you can carry backward or forward."

[tagteam]

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@nash123456 wrote:

.....this does not constitute a passive loss but it can be applied towards the rental income that I may receive in 2024. Did I get this right?

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You got that right; that is correct. Your nonpassive loss from the sale can be used to offset the rental income (or any other type of income, for that matter).

[nash123456]

Great, now I need to make sure I recoup all the back rent in 2024. It’s very unlikely but…

[nash123456]

What are your thoughts for the same scenario if miraculously the sale happens in 2023?

[Mike9241]

whe you fully dispose of rental real estate in a taxable transaction the passive nature is gone. any suspemded passive losses will be allowed as non-passive. even the loss on sale is not passive. it should flow to form 4797 and from there to line 4 of schedule 1.

so if you sell the property in a year before receiving the final rent, I would treat the rent as nonpassive - other income. 

[tagteam]

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@Mike9241 wrote:

so if you sell the property in a year before receiving the final rent, I would treat the rent as nonpassive - other income. 

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I would tend to agree because if the condo is the only rental real estate and it is already sold, there should be no more suspended passive losses (from operations). 

[nash123456]

Thank you all. 

is the form 9727 something that I need to do manually with TurboTax, or will it automatically direct there due to the sale of the condo?

[tagteam]

Form 4797 and TurboTax will complete the form for you (during the interview).