Possible error in allowed losses offseting regular income -Turbo Tax Premire - Max OS

[klkaylor]

I was modeling the sale of my rental house for 2022. Saved a separate file/renamed then used easystep to add the sale (house v. lot, etc). Upon completing the form I noticed that I had a 0 income for 2021.

In reviewing the forms it appears that for some reason on Schd E worksheet for the rental house it puts in all of the carryover losses into the yearly expense form rather than just enough to zero out the profits. This is shown on line 22 Schd E worksheet for that property. Interestingly it does this for both properties I own even though I am only selling one. If I look at the form on the one not showing the sale on line 22 is only enough carryover loss to zero out the profit from the year.

Then on page 2 of schedule E the house sale file shows all carryforward (those include partnerships, trusts ect.) losses to be allowed - totaled on  line 41, and moves that data to Schd 1 for form 1040.  This essentially allows for all of my carryforward losses to be offset against my income rather than limit of 3K.  This is how it is handled on the file without the house sale. 

On the file without the house sale, only 3K is "used" from the carryover capital gains worksheet to offset a small portion of my regular income and the residual losses are shown on the carryforward worksheet. 

Schedule D is the same on both files and shows the 3K loss being moved to line 7 of form 1040

I think the error is in Schd E part II where the form in the file with the house sale takes all capital losses, shows them as allowable losses, (the carryovers are shown as unallowed losses on Schd E part II of the file without the house sale) that then transfers to Schd 1 line 5 that then goes to line 8 form 1040.

While I have enough long and short term losses that the house sale will be zero out. I should have about 200K of carryforward rather that using it against my regular income.

I know this is complex, but I think I understand the law/rules and I believe that the program is making an error in allocating long and short term capital gains to offset more than 3K or regular income.

I am happy to provide either screenshots or my files for review or correcting my knowelge.

[Carl]

I was modeling the sale of my rental house for 2022. Saved a separate file/renamed then used easystep to add the sale (house v. lot, etc). Upon completing the form I noticed that I had a 0 income for 2021.

I assume you were modeling this in TurboTax 2021 desktop version "as if" you sold the property in 2021.

When you sell a rental property, all suspended losses are released in the year of the sale from all "other" income, provided of course you have the "other" income to claim those losses against.

Also, if the rental property has multiple assets, things have to be done a certain way in the TTX program, or you risk the possibility of incorrect depreciation recapture, among other issues. The guidance is below.

Reporting the Sale of Rental Property

If you qualify for the "lived in 2 of last 5 years" capital gains exclusion, then when prompted you WILL indicate that this sale DOES INCLUDE the sale of your main home. For AD MIL personnel who don't qualify because of PCS orders, select this option anyway, because you "MIGHT" qualify for at last a partial exclusion.

Start working through Rental & Royalty Income (SCH E) "AS IF" you did not sell the property. One of the screens near the start will have a selection on it for "I sold or otherwise disposed of this property in  2021". Select it. After you select the "I sold or otherwise disposed of this property in 2021" you continue working it through "as if" you still own it. When you come to the summary screen you will enter all of your rental income and expenses, even if it's zero. Then you MUST work through the "Sale of Property/Depreciation" section. You must work through each individual asset one at a time to report its disposition (in your case, all your rental assets were sold).

Understand that if more than the property itself is listed in your assets list, then you need to allocate your sales price across all of your assets.  You will only allocate the structure sales price; you will NOT allocate the land sales price, since the land is not a depreciable asset.  Then if you sold this rental at a gain, you must show a gain on all assets, even if that gain is $1 on some assets. Likewise, if you sold at a loss then you must show a loss on all assets, even if that loss is $1 on some assets.

Basically, when working through an asset you select the option for "I stopped using this asset in 2021" and go from there. Note that you MUST do this for EACH AND EVERY asset listed.

When you finish working through everything listed in the assets section, if you ever at any time you owned this rental you claimed vehicle expenses, then you must also work through the vehicle section and show the disposition of the vehicle. Most likely, your vehicle disposition will be "removed for personal use", as I seriously doubt you sold your vehicle as a part of this rental sale.

[klkaylor]

Thanks - followed your direction and completed the "sale" of all items listed on the asset list.

This did not help.  

Again two things make me think that there is an error in the work flow -

I understand that if it is sold all "losses" will be released for that property and that could possible be the reason for the line 22 transfers from form 8582 for property A but as property B was not sold why would it "release" all possible losses for that property again on line 22.

I still do not think that the program should "release all possible carryover losses " to be used on line 8 of 1040 against (passive losses and capital gain losses) ordinary income.

[Critter-3]

You need to review the entire return carefully especially the form 4797 and the 8582  ... when you sell a rental the losses for that rental is released to the Sch E and the depreciation that is recaptured is passive income that can be used against passive losses  AND it is possible that your income is below the $150K  mark so more the other passive losses were released.  

[CarissaM]

@klkaylor Can you provide us with more information so we can look into this for you?

[Mike9241]

if i understand correctly, you indicated you sold your rental using the 2021 tax software. passive suspended losses were allocated between your properties. selling one frees up the suspended passive loss regarding that property.

[klkaylor]

What would work for you - the file, screen shots - I think I have given a good written description so don't want to beat a dead horse. Maybe share a screen on a video chat?

[klkaylor]

That I understand - but two other issues exist

1. On schedule E it puts in the carried forward all of the unalloyed losses for the rental that sold but also for a rental that was not sold?

2. It released all prior year disallowed passive losses that then allows allow of my regular income to be negated. My MAGI is greater than 150K so to the best of my understanding I am only allowed to use prior disallowed/carry forward losses to offset 3K of ordinary income.  So why did it allow it to use 6 figures of carry forward losses and bring my income to 0?

[MarilynG1]

Since we can't see your return in this forum, you may want to consult with TurboTax Live for your individual situation.

Click this link for more info on Passive Loss Release Creating Negative Income.

[AmeliesUncle]

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@klkaylor wrote:

1. On schedule E it puts in the carried forward all of the unalloyed losses for the rental that sold but also for a rental that was not sold?

2. It released all prior year disallowed passive losses that then allows allow of my regular income to be negated. My MAGI is greater than 150K so to the best of my understanding I am only allowed to use prior disallowed/carry forward losses to offset 3K of ordinary income.  So why did it allow it to use 6 figures of carry forward losses and bring my income to 0?

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The program seems to be doing it correctly.

Your Passive Loss Carryovers can be used if you have Passive Income.  Because you sold the one rental at a gain, you now have Passive Income, which releases that amount of Passive Loss.

[klkaylor]

I want to recognize all of you who have put forth input into this issue.  I know that it is quite complex given that it involves ordinary business losses/carry overs, depreciation recapture,  short and long term capital gain loses/gains/carry overs, passive real estate losses/carryovers, trust loses/carry overs, and ordinary/earned income. It involves over 15 forms and worksheets in each return. I spent 4 hrs comparing two different returns with the only difference being the sale of the house. I corrected the error that I had made in that I had to account for the selling of all capital upgrades involved with the house - a helpful hint.

The bottom line is that while I think the program did the correct thing in using all forms of "losses" to bring the taxable capital gain from the house sale to zero, although I have some issues with the methodology.  I think it fails terribly in the fact that it uses the residual of all forms of  losses from "zeroing out" the house sale to be used agains "earned income", to bring my total tax to zero for the year.  

I have dealt with these issues for over 30 years using Macntax/Turbo tax without a single audit. Unless someone can quote the IRS rule allowing for passive losses  to offset earned income (understanding the 25K offset for MAGI under 150K) and/or capital losses  to offset more than 3K of earned income, then this program has an error.  I would not file this return as produced due to this error.

The good news is that this was a modeling event to look at how much carry forward losses would be left if I did a sale v. a 1031 exchange in 2022. 

Again I am happy to screen share and discuss this issue.  The simple answer as provided above is true and correct and I agree and understand, however it fails to grasp the full complexity of issue - it is much more than just passive losses offsetting passive gains.  

[AmeliesUncle]

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@klkaylor wrote:

The bottom line is that while I think the program did the correct thing in using all forms of "losses" to bring the taxable capital gain from the house sale to zero, although I have some issues with the methodology.  I think it fails terribly in the fact that it uses the residual of all forms of  losses from "zeroing out" the house sale to be used agains "earned income", to bring my total tax to zero for the year.  

I have dealt with these issues for over 30 years using Macntax/Turbo tax without a single audit. Unless someone can quote the IRS rule allowing for passive losses  to offset earned income (understanding the 25K offset for MAGI under 150K) and/or capital losses  to offset more than 3K of earned income, then this program has an error.  I would not file this return as produced due to this error.

Where is your citation from the IRS about why you think it is incorrect?

As I stated above, Passive Losses are allowed to the extent there is Passive Income.  No, it does not need to directly offset that Passive Income (capital gains) - the Passive Losses don't lose their 'character' of being 'ordinary' (rather than 'capital').

[dolphine1234]

I hope I understand this correctly. 

If I have two rental properties A and B and I sell A only for a gain, the unallowed passive losses from both properties A and B will be released.  Can someone confirm? Thanks

[Carl]

While I can't find any publication where it just comes right out and states it with any degree of clarity, based on my understanding/interpretation of the instructions for IRS Form 8582, in the tax year you sell the property, taxable gain realized on the sale is reduced by the "total" of "all" previously unallowed/suspended passive activity losses.

[dolphine1234]

Thanks. I'm working on 2023 tax and TurboTax does exactly that.