Most of us know that $250K of gain is exempt from tax on the sale of your primary residence ($500K if married) if you lived in that house for 2 of the last 5 years. But what if you sell your house at a loss? Tough luck the IRS says. Losses are not deductible on the sale of your personal residence. Or are they?
In fact, if you are planning to sell your home and you feel that market values are beginning to rapidly deteriorate, you should consider renting out your house prior to selling with a Residence to Rental Conversion Tax Strategy. This Residence to Rental Conversion (RRC) allows a deductible loss on the sale of your personal residence. And it is absolutely legal. So hold on to your seat as we take the RRC tax savings tax strategy journey to the work around needed for you you to protect and bullet proof your tax return in the event of an IRS audit.
First we head back to year to 2013: You are married earning $215,000 on a W2 annually. You have a 10 year old son. Your spouse manages the household but earns no income. You also have $13,000 of dividends/interest and a $3000 capital loss carryover. Your AGI is $225,000. You decided with your spouse in early 2013 that you plan to move to Texas for a better job and you are putting the house up for sale on July 1 2013. You listed your house for $200,000 which was the Zillow appraisal on July 1, 2013. Six months later the house sold for $150,000. You really feel bad because you paid $250,000 for that house a few years earlier. So you lost $100,000 off the original price and you lost $50,000 from the date the house was listed.
When you meet your CPA to file your 2013 tax return you feel confident that you can deduct some of this loss when your house sold. Your CPA who used to work for the IRS says “tough luck” you cannot deduct a loss on the sale of your personal residence. As a result you had a $40,000 tax bill in 2013 which you paid but with much upset because you feel you should have been able to deduct some loss on the sale of your home.
But here is what could have happened if you traveled a wiser path perhaps to a wiser tax advisor who know all about the RRC tax strategy: Same facts as above except you also listed the house for rent as well as for sale. The house is sold six months later for $150,000 just like before but now you have a legal and deductible loss. Your deductible loss is $50,000. ($200k-150k). You cannot take the full $100,000 loss because the government does not want you to include in your loss the portion of the loss incurred while living in the house, only to include in your loss the portion of the loss incurred while the house was listed for rent. Just so you know, I ran some numbers on your 2013 tax return. When we subtract a $50,000 loss your tax drops to $20,000 a savings of $20,000! This $20,000 tax savings is real money in your pocket.
But there is more good news for anyone who successfully implements an RRC. In this example, even if your house never rents out before it is sold you still get the $20,000 tax savings. You just have to jump through some easy promotional hoops as follows: Include a proper and valid listing for rent agreement, advertisements for rent and most important place outside the house a sign for rent. All this advertising can be documented photographed and assembled as part of your tax filing and even attached to your tax return in PDF. Don’t make the mistake that Bill and Nancy Turner made in US Tax Court Summary Opinion 2002-60. As Judge Vasquez noted: “Petitioners never placed a sign in front of the Belair property nor ran any newspaper advertisements listing it for rent. Furthermore, the renovation of the Belair property prevented it from being rented. By the time petitioners could have rented the Belair property, petitioners had decided “to get rid of” the Belair property. Petitioners never rented the Belair property, and it remained unoccupied until the new owners moved in….” Id at 4
So in conclusion, if you are planning to list your home for sale at a loss, don’t just ride the elevator down for a few months without any tax savings. Implement a Residence to Rental Conversion Tax strategy for some real cash flow tax savings that takes the sting out of selling your home at a loss and puts some cash back in your pocket. Thanks for joining me and see you next time on Tax View.
Chris Moss CPA