Selling a converted rental for less than original cost

[mra311]

I purchased a house in 2004 for $160,000.  In 2012 I needed to move, but could not sell the house due to the housing market crash.  I converted it to a rental in 2012.  I still owed $130,000 on the house, but the FMV was only $90,500.  I had to use the lesser of the two to calculate deprection.  I sold the house in 2019 for $151,000 (still less than the original price).  After paying off the outstanding mortgage I received $37,000 at closing. 

When entering these numbers into TurboTax under Rental and Royalties, it shows I had a huge gain and I owe a lot of taxes.   The rental had $22,021 in depreciation.  I never made a profit on the rental as I only charged rent to cover my mortgage cost. 

Is this correct?  Why do I need to pay so much taxes when I sold the house for less than the original cost?  If I entered the information in the the Sale of Business section then it does not show I have a gain. Can I use this section to report the sale? 

[Carl]

Since you did not (because you could not) use the original cost basis to depreciate the property while it was a rental, you flat out can not report the sale in the Rental & Royalty Income (SCH E) section of the program. That'sw because the program will be basing your loss/gain on the adjusted cost basis used for depreciation, which we both know is wrong.

You have no choice but to report the sale in the "sale of business property" section. Pay attention so that you select NO on the first screen, since you did not sell the property at a gain.

[RobertG]

Unfortunately, it sounds like you had a gain on the sale.

Your tax basis in a converted personal residence for tax loss purposes equals the lesser of: (1) the property’s normal tax basis on the conversion date or (2) the property’s FMV on that date.

This  rule is intended to disallow a loss from a decline in value that occurs before the conversion date. That loss is personal and nondeductible.

So, from a tax standpoint, you took a $90,500 asset, claimed $22,021 in depreciation, and sold it for $151,000.

If you report those facts correctly, it should not matter where you report it, you will still have a gain.  The amount of your mortgage does not figure into the calculation. 

[Carl]

Why do I need to pay so much taxes when I sold the house for less than the original cost?

Depends on your selling price when figured against your "adjusted" cost basis after subtracting depreciation from it.

Remember, your adjusted cost basis is what you paid for it, minus all depreciation taken. So if you sold it for anything over that adjusted cost basis, you have a taxable gain. As I'm sure you're aware, recaptured depreciation is taxed no matter what. That is, unless your sales price wipes it out entirely, based on the adjusted cost basis.

It's really weird because in your specific case, if you sell at a loss, your cost bases is the FMV when placed in service. This will effectively reduce your tax deductible losses.

But if you sell at a gain, your cost basis is what you paid for the property (since it's higher). This effectively reduces your taxable gain.

But if your sales price results in a gain based on FMV at time of conversion, *and* a loss based on purchase price, that's not clarified in any IRS publication I can find. So I guess you just "flip a coin".

So if you're not totally confused at this point and realize you may need professional help this year, then it's obvious you haven't been paying attention. 🙂

[mra311]

If I report the rental sale in the Sale of Business Property section then how do I close out the rental in the asset/depreciation section under Rental and Royalites? (I had the rental house itself listed as asset and took depreciation on). What do I enter for the Assest Sale (Buiness portion only), Asst Sales Expenses..etc?  If I leave it blank then I dont know if TT will close out the asset.  If I enter Zero then refund dramatically increases, which I know cant be correct.  

[ColeenD3]

If your property was not held out as a rental in 2019, you can't take depreciation for 2019. If you did then you can manually add the depreciation calculated in the Rental section into Sales of Business Property.

However, you said that you took the lower of AB or FMV for depreciation (as you should have). IF you had a loss, again, the program would have picked up that amount properly. But, as mentioned, the depreciation has to be taken into consideration.

Calculating Gain/Loss on Subsequent Sale of Rental Property

If a residence converted to rental property is later sold at a gain, the basis in the converted property is the original cost or other basis plus amounts paid for capital improvements, less any depreciation taken.

 If the sale results in a loss, however, the starting point for basis is the lower of the property’s adjusted cost basis or FMV when it was converted from personal.

(Regs. Sec. 1.165-9(b)(2)).

[mra311]

Coleen,

It was rented until June 30, 2019.  

It appears if I use the original cost I would still have a slight gain after subtracting depreciation. Therefore I would enter the sale of the home in the Sale of Business Property section(not the Rental and Royalites section under property sale/ depreciation because that it using the FMV at conversion). 

So, my question is what do I enter in the sales/depreciation section in order to show a disposition for each asset (home and other assets)?  It asks for sale cost, sales, expense, etc. 

[ColeenD3]

Since it was rented in 2019, you will have to enter that information in the Rental section to show the income and expenses. If you use the SBP section remember to include 2019 depreciation.

If you are not including everything as one asset sold, you will need to prorate the sales amount and sales expenses for each asset.

For example, since land is separate from the house, if sales price is 80% house and 20% land, the sales expense would be prorated the same.

[Carl]

So, my question is what do I enter in the sales/depreciation section in order to show a disposition for each asset (home and other assets

No, no no. That's not the right way since you're not reporting the sale in the SCH E section of the program.

Work through the SCH E section and select the option for "I sold or otherwise disposed of this property in 2019". Then continue working it through reporting your rental income and expenses up to the closing date of the sale.

Now work through the "Sale of assets/Depreciation" section and on each asset work it through and select the option for "I stopped using this asset in 2019". Then on the "special handling required?" screen  you "MUST" select YES. If you select no you will be *forced* to enter sales information, and we don't want to enter that on the SCH E. Now remember to write down the prior year depreciation and current year depreciation for each asset as you work this through, because you will need the "TOTAL" of all depreciation taken up to the date of the sale, when you enter your sales data in the "Sale of Business Property" section.