how to enter 1099-S with complicated scenario?

[SPY]

My brother and sister, together with myself, co-inherited a home when our father passed last year. The appraisal on date of death gave a FMV of $1,125,000, so our share worked out to $375,000 apiece. My sister has lived in the home as her primary residence for many years although previously it had been a rental with significant "suspended" passive losses (my share = $30,213). She decided to buy out her 2 brothers for a sale price of $750,000 ($375,000 in cash to each of us, officially reported on a 1099-S), which was smoothly accomplished with the help of an estate attorney. After depreciation recapture, the capital gain (my share = $18,958) was completely offset by the passive losses which were then "unsuspended". The question now is whether my remaining loss (over $17,000 when other sales-related costs are included) is considered a capital loss (problematic in non-arm's length transactions between relatives) or a passive loss that can be carried forward to offset my other rental income (or $3000 of my ordinary income)?

[tagteam]

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@SPY wrote:
The appraisal on date of death gave a FMV of $1,125,000, so our share worked out to $375,000 apiece. 

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I am sorry for the loss of your father.

Please feel free to ask any questions you have after reading the short passage below, since you are obviously aware that the valuation is the fair market value as of the date of death.

You are laboring under the misconception that accumulated deprecation, passive losses, et al, continue to attach to the property post death; they do not. The property receives a stepped-up basis and any accumulated depreciation, suspended losses, et al, are simply wiped out.

Your (share of the) basis is the fair market value (~$375,000) as of the date of death which you would simply subtract from the amount you realized from the sale (sales price less selling expenses). 

[HelenC12]

First of all, if this is an inherited house, there is no depreciation or suspended losses to contend with. That ended with your father's passing.

• You wouldn't need to report depreciation recapture since this was not your rental and you didn't report depreciation in year's past. Your father did and that ended with his passing.
• You wouldn't have suspended losses since you didn't own the property. The suspended losses belonged to your father. They ended with his passing. 
• Your basis in an inherited property is usually the Fair Market Value (FMV) at the time of inheritance plus any capital improvements made to the property since inheriting it.

If your name was on the title or deed of the house prior to your father's passing, then it's not an inherited home. It's just another property you (and other's) own. 

[SPY]

I must clarify a few details:

1) The property was technically not my father's but held in a bypass trust (irrevocable after my mother's death in 2004) and I was one of the successor trustees (together with my 2 siblings).

2) At the time of my father's death, the deed was in the name of that trust, but shortly afterwards it was transferred to all 3 children as tenants in common.

3) The suspended losses then belonged to the trust (not my father), so shouldn't I be able to claim the suspended passive loss as well as the current capital loss? 

[tagteam]

That does make a difference.

Generally, as a result, you would take a carryover basis in the property you received from the trust, complete with any passive losses or accumulated depreciation that attached after the death of the first to die (your mother).

Problematic, however, are the suspended passive losses since, in order for those to be released, you need to dispose of the property in a fully taxable transaction to an unrelated third party,

[Carl]

One minor correction needed here.

Your basis in an inherited property is usually the Fair Market Value (FMV) at the time of inheritance plus any capital improvements made to the property since inheriting it.

No. Basis is the FMV at the time of the passing of the deceased. Not the time of inheritance. Some times it can take years to dissolve an estate and the beneficiary recipient not actually receive or have any control of the property until such time. In some cases, that can take years.

When in a revocable trust, that trust normally becomes irrevocable upon the passing of the grantor of the trust. So FMV is still based on the date of the grantor's passing, not the date the beneficiary recipient gets possession/control of it.

[SPY]

Thanks @tagteam, but my sister's CPA has prepared a FTB form 593-E (as required by the state of CA) which credits me with the depreciation as well as the suspended passive loss, resulting in a net capital loss of over $17,000. Where can I enter this transaction in TurboTax? I tried to do that within the rental property section but it was really never rented while owned by me (my sister lived there as her primary residence), and there was no obvious way to account for my situation ...

I understand the rationale of the IRS "arm's length" rule is to prevent sales to relatives below FMV merely for the purpose of creating a passive loss, while keeping the property within the family ... or even worse when associated with some "under the table" transaction whereby a seller reimburses a buyer for the sales price. My sister paid FMV as determined by a professional appraiser x 2. She simply wanted to live "free and clear" without paying rent to her brothers, and sold another of her inherited properties to pay for this one (nothing "under the table" involved here)!

[tagteam]

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@SPY wrote:

My sister paid FMV as determined by a professional appraiser x 2.

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Except it makes no difference whatsoever that she paid FMV because tax law does not take the price paid into consideration; it simply prevents passive losses from being released until the related party disposes of the property in a fully taxable transaction (per IRC §469(g)(1)(B)).

If you insist on entering this transaction, considering it carries with it prior depreciation, passive and capital losses, I cannot imagine entering it using any method other than as the sale of rental property (despite the fact that there is no rental income). Alternatively, you could use Forms Mode and enter it manually, but doing so would most likely require overrides and would risk one or more input errors.

[SPY]

By "prevents passive losses from being released until the related party disposes of the property in a fully taxable transaction" do you mean when my sister sells to somebody unrelated in the future? As for entering the current sale, TurboTax forces me to take current depreciation of $7098 (presumably for the period between 2/3/19 when my father passed and 8/20/19 when the sale to my sister closed) ... does that seem right to you? Where will I find the previous passive losses that should have been unsuspended?

[tagteam]

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@SPY wrote:

By "prevents passive losses from being released until the related party disposes of the property in a fully taxable transaction" do you mean when my sister sells to somebody unrelated in the future? As for entering the current sale, TurboTax forces me to take current depreciation of $7098 (presumably for the period between 2/3/19 when my father passed and 8/20/19 when the sale to my sister closed) ... does that seem right to you? Where will I find the previous passive losses that should have been unsuspended?

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Yes, not until your sister sells to an unrelated third party.

The depreciation does not sound correct unless the property had been rented during that period.

I am not sure how your CPA dealt with the losses so you might have to ask the CPA directly.

[SPY]

I was advised by someone at H+R Block to treat this sale as "undeveloped land" or some other business asset rather than a rental property. That would avoid the inappropriate depreciation and probably also side-step the unrelated parties issue (only required for rental real estate investments?) ... presumably I could then claim a capital loss because the suspended passive losses are effectively capitalized within the adjusted basis. What do you think about that?