Discussion:Loss on rental property - ordinary or capital loss???

From TaxAlmanac, A Free Online Resource for Tax Professionals
Note: You are using this website at your own risk, subject to our Disclaimer and Website Use and Contribution Terms.

From TaxAlmanac

Jump to: navigation, search

Discussion Forum Index --> Basic Tax Questions --> Loss on rental property - ordinary or capital loss???


Discussion Forum Index --> Tax Questions --> Loss on rental property - ordinary or capital loss???

Kendrick (talk|edits) said:

31 March 2010

I am getting mixed messages. Some say ordinary, some say capital. What I read is that if you can show the IRS that you are profit-motivated with your investment in the rental property (which is generally the case), then you get an ordinary loss if sell for a loss.

I know there are other discussions in Tax Almanac on this subject, but I couldn't find them.

Anyone have a decisive straightforward answer?

Kevinh5 (talk|edits) said:

31 March 2010
§1231 loss is an ordinary loss

KathiJud (talk|edits) said:

1 April 2010
Did the taxpayer own and use the property as a rental to qualify for a 1231 loss? If held as an investment and not really ever rented out by your TP it may be a capital loss. Careful of any loss in value if used for personal reasons before it became either a rental or investment property.

LH2004 (talk|edits) said:

April 1, 2010
A rental property, even one actually rented, is not necessarily used in a trade or business, especially if it's the taxpayer's only rental property. In some circuits, at least.

The Second Circuit, for example, seems to require that the rental involve "an appreciable amount of time and work" (by someone) to constitute a trade or business. See, for example, Murtaugh v. Commissioner, T.C. Memo 1997-319 (applying Second Circuit law, quoting from Grier v. United States, 218 F.2d 603 (2d Cir. 1955)). One property rented to the same tenant for a long time will rarely meet the test.

The law in the Court of Federal Claims and the Seventh Circuit seems to be similar, if a bit easier on taxpayers, and the Sixth Circuit seems to be confused. In other circuits, at least in the Tax Court, most rental properties should qualify for sec. 1231.

Kendrick (talk|edits) said:

1 April 2010
So what does one do? We buy rental properties, except for the rare exception, with a profit-motive. We hope to not only profit from appreciation, but we hope to have a nice flow of cash from it eventually (which will be taxable as ordinary income), after the mortgage is paid off. Therefore, if we have a profit motive, we should get 1231 treatment in the case where there is a loss. Even the guy with one rental property.

I will review these cases you present LH2004. Thank you.

With this real estate crash, we should get some new cases on the roster. It will be interesting to see how they pan out . . .

Just out of curiousity, have any readers been up against this yet, and did you treat the loss as ordinary or capital? What are we doing out there??? I think it was you KathiJud who said you have a lot of real estate clients. What do you do here? Have you treated any such losses as ordinary or capital?

Doug M (talk|edits) said:

1 April 2010
I am not sure where you are getting mixed messages. Kevin gave you an answer that I 100% agree with. Now, if you convert a principal residence to a rental to try and get an ordinary loss, I am going to start asking questions that Kathi asked, (FMV on date of conversion) which were spot on also.

I have no idea about the case LH referred to where he said--"One property rented to the same tenant for a long time will rarely meet the test." I never have seen anything that relates to the number of tenants that you had as the application to IRC 1231.

I would love a tenant like that and take IRC 1231/1250 in a NY second.

Taxea (talk|edits) said:

1 April 2010
why would one call a property a rental if it was never rented?

KathiJud (talk|edits) said:

1 April 2010
I report appropriate amount of losses on rental properties as ordinary losses under 1231.

LH2004 (talk|edits) said:

April 1, 2010
I agree with Kevin that sec. 1231 losses are ordinary. I agree with Kathi that the "appropriate" amount of losses may be deducted. I don't agree that you can blindly treat all losses on rental properties as 1231 losses, and neither does the IRS. See PLR 8350008, which distinguishes or dismisses a hefty stack of private rulings, informal notices, etc. that seem to reach the opposite result.

You can't just ignore the cases that went against you. If your taxpayer never sets foot outside of the Ninth Circuit, there may not be any; but, then, there aren't a whole lot in your favor either, for some combination of the reasons that not a whole lot of landlords have historically lost money faster than depreciation; not many of those who did chose to sell before it recovered; some of those who did never heard of sec. 1231 and treated it as a capital loss; and the IRS didn't get around to challenging some who claimed 1231 treatment.

Where I live, a return treating as ordinary a loss on the taxpayer's only rental property, absent unusual circumstances, is frivolous. You can sign those, but be sure to write "APRIL FOOLS" in large print under your signature.

Doug M (talk|edits) said:

1 April 2010
I am in the 9th circuit. I never knew that other circuits characterized rental property sold at a loss capital losses.

I guess LH has made me rethink this. I finished a return last week, son owns rental house rented to mom at FMV. Newer client to me, but I think the only tenant he has ever had is his mom.

What I am hearing from LH is that if this property was sold at a loss, and it wasn't the 9th circuit I should write APRIL FOOLS on top of the 4797 when I file. When the time allows, I will look at the cases cited above and find out.

Kevinh5 (talk|edits) said:

1 April 2010
I am writing "APRIL FOOLS" on the signature line of every return showing a refund today.

Kevinh5 (talk|edits) said:

1 April 2010
somehow the clients don't seem to think it is as funny as I do, though.

Kevinh5 (talk|edits) said:

1 April 2010
one recent widow must not have a sense of humor

she was crying as she left my office

Kevinh5 (talk|edits) said:

1 April 2010
&^%@ them if they can't take a joke, right?

Harry Boscoe (talk|edits) said:

1 April 2010
IIRC, there is an IRS Publication that clearly states that losses from the sale of rental properties are generally Section 1231 losses.

There you have it: Neither ordinary nor capital loss.

Final Answer. Authoritative final answer. The Pubs have it. Over and out. Time to go to the fridge.

DaveFogel (talk|edits) said:

1 April 2010
My article on rental property foreclosures (http://fogelcpa.com/Documents/FogelRentalForeclCSEA.pdf) contains some discussion of this issue.

I don't agree with LH2004 that the renting of one property is not a business, and neither do the courts. In the case cited (Murtaugh v. Commissioner, T.C. Memo. 1997-319), the Tax Court held that the taxpayers were engaged in a business with respect to the renting of their timeshares and were entitled to ordinary loss treatment upon their disposition. I think that it depends upon the facts and circumstances.

Historically, the courts have held that the rental of even a single property may constitute a trade or business under various provisions of the Code. See, e.g., Hazard v. Commissioner, 7 T.C. 372 (1946, acq. 1946-2 C.B. 3); Post v. Commissioner, 26 T.C. 1055 (1956, acq. 1958-2 C.B. 7); Gilford v. Commissioner, 201 F.2d 735 (2d Cir. 1953); Schwarcz v. Commissioner, 24 T.C. 733 (1955, acq. 1956-1 C.B. 5); Elek v. Commissioner, 30 T.C. 731 (1958, acq., 1958-2 C.B. 5 ); Fegan v. Commissioner, 71 T.C. 791 (1979), aff’d. 81-1 USTC (CCH) 9436 (10th Cir. 1981); Pinchot v. Commissioner, 113 F.2d 718 (2d Cir. 1940). Furthermore, the IRS has apparently backed away from its position, as stated in TAM 8350008 that the mere rental of property doesn't constitute a business.

Accordingly, if the property was continuously rented at fair rental value to an unrelated tenant for a period of time that established that the property was a bona fide rental, then ordinary loss treatment under IRC §1231 should be allowed. If I were preparing the return, I would at least take that position as having substantial authority.

Kevinh5 (talk|edits) said:

1 April 2010
Kendrick - never ask for a decisive straightforward answer. Apparantly there aren't any.

LH2004 (talk|edits) said:

April 1, 2010
What evidence is there that the IRS backed away from its position in PLR (I assume you meant, not TAM) 8350008? I think the IRS position is still exactly the same: not litigating the issue when it thinks it will lose, but not at all agreeing that, as a matter of law, every rental property qualifies under sec. 1231. The 10th Circuit's decision in Fegan was about sec. 482, not 1231. Of course a rental can constitute a business, but the facts-and-circumstances test the Second Circuit articulated in Guile won't typically be met by renting out one property to one tenant and not doing an unusual amount of work. Gilford, the older case, finds a loss to be ordinary (in a case involving 8 properties), but the Second Circuit has indicated pretty clearly that it intends to follow Grier, if it's in conflict with Gilford.

Murtaugh held a loss to be ordinary, but that involved two properties, and the taxpayer only won by showing evidence of undertaking "an appreciable amount of time and work" (through agents). Other cases, like Guggenheimer v. Commissioner, 209 F.2d 362 (2d Cir. 1954), and Union National Bank v. U.S., 195 F. Supp. 382 (N.D.N.Y. 1961), have held taxpayers' losses on actual, genuine, rented-out properties to be capital. You can't just wish these cases away.

Most of the circuits haven't addressed the issue. I think that, if they did, they would reach a result as unfavorable as the Second Circuit's, or worse (given the higher standards they've accepted under sec. 355 and 1402). The Tax Court will follow its own decision in the Hazard case in most circuits, so there is at least substantial authority there to take the position that any rental qualifies for sec. 1231, though you may want to advise your clients that there is some risk of losing; in the rare situations where you prefer a capital loss, you can probably convince yourself that there is substantial authority for that position, at least in the circuits that have been silent.

But in the Second Circuit, the only way to have an ordinary loss without showing "an appreciable amount" of activity is to either convince the Court of Appeals to reverse itself or to get the Supreme Court to do that. I'm not an expert on Circular 230 standards, but that sounds to me like the kind of position that you get in trouble for taking. Maybe the question is moot because you can claim that, even under a long-term net lease, the 5 minutes a year you spend checking that the property hasn't been vaporized by aliens is "appreciable," but that's a heck of a stretch.

I don't think that IRS publications get you anywhere, at least if you know they're wrong. PLR 8350008 dismisses the taxpayer's attempt to use Pub. 544 on this exact issue: "Pamphlets published by the Service are treated like information letters. They are not designed to be relied upon by taxpayers in planning future transactions. This was reaffirmed in Adler v. Commissioner, 330 F.2d 91 (9th Cir.1964). The court, in denying the taxpayer's claim, stated '... nor can any interpretation by taxpayers of the language used in government pamphlets act as an estoppel against the government, nor change the meaning of taxing statutes ...' See also the recent decision in Manocchio v. Commissioner, 710 F.2d 1400, 83-2 U.S.T.C. P9478 (9th Cir.1983), or 710 F.2d 1400, 52 A.F.T.R.2d 83-5566 (1983)." But maybe that is enough to avoid penalties.

DaveFogel (talk|edits) said:

1 April 2010
Regarding your question of what evidence there is as to why I think that the IRS has backed away from its position as stated in TAM 8350008 (and this is not a private letter ruling, but rather, a Technical Advice Memorandum), the IRS recently ruled that a single rental property was a business for purposes of the Qualified Real Property Business Indebtedness exclusion of IRC §108(c). See CCA 200919035 at http://www.irs.gov/pub/irs-wd/0919035.pdf. And in Rev. Proc. 2008-16, 2008-10 I.R.B. 547, the IRS provided a "safe harbor" for purposes of IRC §1031 by stating that a dwelling unit will qualify as property held for use in a business or for investment if the taxpayer rents it for at least 14 days during each of two 12-month periods preceding the exchange and doesn't use the dwelling unit personally for more than period specified in IRC §280A(d).

We can go on arguing this and throwing cases back and forth until both of us are blue in the face. I think you're wrong, and you think I'm wrong. So, let's just "agree to disagree."

Doug M (talk|edits) said:

1 April 2010
LH: Disagree 100% on your statements/facts regarding Murtaugh. He by admission, after the property was acquired, did absolutely nothing.

The only thing he did was to "visit" the properties on a very limited basis in the off season.

He had a management company that did EVERYTHING for him. Bookings, leasing, R&M, cleaning, absolutely everything

Courts granted IRC 1231 loss.

Kendrick (talk|edits) said:

2 April 2010
That is it. I am convinced. Sec 1231 loss, end of story (except for the unusual situation). It is clear to me from the above that this is the stronger consensus. You others may be losing your clients some ever so sweet deductions.

I bet there will be more case law on this soon!


OCNumberz (talk|edits) said:

22 March 2012
Kevinh5: Kendrick - never ask for a decisive straightforward answer. Apparantly there aren't any.

The more I read, Kevin, that certainly seems to be the case. More good Dave Fogel info here, though.  :) Personally, I thought your APRIL FOOLS joke was pretty cute!!

To join in on this discussion, you must first log in.
Personal tools