Discussion:Sale of Duplex - 1/2 Personal and 1/2 Rental

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Discussion Forum Index --> Tax Questions --> Sale of Duplex - 1/2 Personal and 1/2 Rental


Deback (talk|edits) said:

February 11, 2007

I have a client who sold a duplex on 04/24/06. He bought the duplex on 06/01/01 and lived in one side until 12/01/04. He rented out the other side from 06/01/01 until the duplex was sold. He also rented out the side he had lived in from 01/01/05 until the duplex was sold.

Does renting both sides in the last 16 months before he sold the property prevent him from using the Sec. 121 exclusion on one-half of the sale price? I think it would be okay to enter one-half of the sales price and one-half of the cost, improvements made to sell, and selling costs, and the accumulated depreciation on Form 4797, but my tired brain is looking for confirmation of this.

Thanks for any help!

Solomon (talk|edits) said:

11 February 2007
121 applies and if there were a suspended loss on the rental (prior residence) the passive loss is deductible upon sale.

Deback (talk|edits) said:

February 11, 2007
Thanks, Solomon! No suspended loss is involved, and I appreciate your confirmation that I'm doing this right.

PGattoCPA (talk|edits) said:

11 February 2007
I agree that §121 applies since the half that was personal was not converted to rental use more than three years prior to sale. However, I do have two disagreements.


Depreciation Recapture

Under the facts the original purchase date is post-May 1997; therefore, under §121(d)(6), gain attributable to depreciation recapture is not excludible.


Suspended Passive Losses

I realize that Deback said that passive suspended losses are not an issue for her particular client, but I disagree that suspended losses would have been freed up if there were any.

Per §469(g)(1)(A), the suspended losses will only be deductible if the entire interest in the passive activity was disposed of in a fully taxable transaction. Since §121 makes the transaction not fully taxable, the losses remain suspended. Unless I missed it, I do not see anything in §121 or §469 or their related regulations to allow deduction of the suspended passive losses. If the taxpayer had other passive income in the disposition year against which the suspended passive losses could be offset, then no biggie.

If not, and 1) there was not a prospect in the future for passive income; and 2) the suspended passive losses were in excess of the otherwise excludible gain under §121, the taxpayer may want to elect under §121(f) to have the §121 excusion not apply.

E.g., gain on sale of $15,000 versus suspended passive losses of $75,000 with no or little prosepect of future passive income. If the §121(f) election is NOT made, taxpayer has $0 (zero) of current year taxable capital gain and keeps the $75,000 suspended passive loss.

If the §121(f) election is made, taxpayer has $15,000 of current year taxable capital gain and a $75,000 current year non-passive deductible loss.

Deback (talk|edits) said:

February 11, 2007
PGatto - Sch E losses were between $3k and $6k every year, so I'm glad I didn't have to deal with passive losses. Your explanation of this makes sense. Also, I included the unrecaptured Section 1250 gain (depreciation recapture), which was $11,605. The total taxable gain on Sch D is $23,158, and the Sec 121 excluded gain on Sch D is $13,653. The difference is for improvements that were allocated 100% to the rental portion.

Death&Taxes (talk|edits) said:

11 February 2007
But what is the passive activity? You have two separate properties divided by a common wall. If Deb's client first separated them by deed, this would indeed by two separate activities, and I believe that failure to do so does not rule out the same treatment in the instant case. My god, the Northeast is dotted with properties like this. In Philadelphia we call them 'twins' but my fiancee from Bergen County NJ calls them duplexes. There are other properties where the rental is atop the personal residence, or v.v. It is common practice at the Jersey shore to 'condo-ize' these and make them two separate properties, but once again I don't see that failure to do so makes them one activity UNLESS there were to be no separate entrance.

Solomon (talk|edits) said:

11 February 2007
121 exclusion does not negate 469(g)(1). A 121 disposal and exclusion is considered a fully taxable transaction.

PGattoCPA (talk|edits) said:

11 February 2007
Solomon: What is your cite for that claim?

PGattoCPA (talk|edits) said:

11 February 2007
D&T: I'm not saying Deback's client had a passive situation. The statement was made that IF there were suspended passive losses, they would be freed up upon disposition. Deback answered that there were none.

I merely added that the code and regulations do not support the freeing up of suspended passive losses in case someone who does have suspended passive losses is in a situation wherein the disposition of the entire passive activity does not involve a fully taxable transaction.


EDIT: D&T: I think I misread your post. I believe it is one disposition, rather than two because of the conversion from personal to rental under the posted facts. Now there probably is a very good position that the half that was always rented out was one activity (and is not "tainted" by the conversion of the other half) and the half that was converted is a separate transaction and, therefore is subject to the rules that I think are applicable. (Although Solomon may have a citation that I am incorrect.)

By the way, be careful of your fiancee. Out here in Northern California we call them duplexes as well. Are you sure she's really from Jersey? <VBG>

Death&Taxes (talk|edits) said:

11 February 2007
Now we are on the same page; I misread your post too! The word 'taint' clears it up.

Kevinh5 (talk|edits) said:

11 February 2007
Pgatto, the "not fully taxable transaction"s I have seen are sale at a loss to a related party and §1031 exchanges. It is my opinion that a §121 exclusion sale IS a fully taxable transaction, it's just that there is an amount exempt from tax (250k or 500k).

Solomon (talk|edits) said:

11 February 2007
PG - Normally a sale to a third party of the entire interest in an arm's length transaction is a fully taxable transaction. It is not a matter of citing a direct cite regarding §121 in the context of Deback's post. It is a matter citing which transactions are not fully taxable transactions. I believe Kevin did this.

PGattoCPA (talk|edits) said:

11 February 2007
Solomon: I disagree. In my opinion you are using the definition of realized as also applying to recognized.

Sec. 469(g)(1)(B) is quite clear when it states, "If all gain or loss realized on such disposition is recognized . . .". Clearly there is a diffrence between the two. I maintain the §121 exclusion keeps the realized gain from being permanetly recognized.

In fact, the Sec. 121(d)(6) reference I mention above is titled, "Recognition of gain attributable to depreciation". Thus, even with the language of §121 itself draws a distinction between realized, but excluded and realized and recognized.

Finally, in the Committee Report for PL 105-34 which enacted the revisions to §121 it states under (then) present law, "No gain is recognized on the sale of a principal residence if a new residence at least equal in cost to the sales price of the old residence is purchased and used by the taxpayer as his or her principal residence . . ." and in referring to the (then) one-time exclusion, "an individual, on a one-time basis, may exclude from gross income . . ." So we have under the former law support for the contention I am making. What about current law?

In the explanation of the new provision the committee report states, "Under the bill a taxpayer generally is able to exclude up to $250,000 ($500,000 if married filing a joint return) of gain realized on the sale or exchange of a principal residence. The exclusion is allowed each time a taxpayer selling or exchanging a principal residence meets the eligibility requirements, but generally no more frequently than once every two years. The bill provides that gain would be recognized to the extent of any depreciation allowable with respect to the rental or business use of such principal residence for periods after May 6, 1997." So once again, the portion that is not taxable is realized, but excluded while the portion that is taxable is realized and recognized.

Therefore, I stand by my contention that the law and regulations (and now the Committee Reports of PL 105-34) under §469 and §121 would cause the suspended passive losses to stay suspended if the taxpayer avails him/herself of the §121 exclusion.

Dennis (talk|edits) said:

11 February 2007
Certainly depreciation recapture willl absorb suspended losses. ♫

Death&Taxes (talk|edits) said:

11 February 2007
It seems to me that Sec. 469(g)(1)(A) is seeking to define one condition, that where a loss is created from the disposal of an activity and that loss is greater than other passive income, the resulting loss becomes a non-passive loss, and that is all it is saying. Did you mean (g)(1)(A)?

PGattoCPA (talk|edits) said:

11 February 2007
Dennis: I agree. §469(g)(1)(A)(i).

So if we added another example where there is $15,000 of realized capital gain, $10,000 of ordinary depreciation recapture and $75,000 of suspended passive losses the results would be as follows.

If §121(f) election not made: $0 recognized capital gain, $10,000 of depreciation recapture offset by $10,000 of suspended losses. $65,000 of remaining suspended losses.

If §121(f) election made: $15,000 recognized capital gain, $10,000 of depreciation recapture offset by $10,000 of suspended losses. $65,000 of remaining suspended losses deducted in the current year.

PGattoCPA (talk|edits) said:

11 February 2007
D&T: We were typing at the same time. Does my reply to Dennis answer your question or do I need to revisit?

Death&Taxes (talk|edits) said:

11 February 2007
I think we are clear.....until someone else muddies the waters!

PGattoCPA (talk|edits) said:

12 February 2007
Kevinh5: Sorry, I completely missed your post above. I believe the difference in the §267 and §1031 transactions you mention is that there is not a "complete disposition" of the activity that generated the suspended passive losses.

The related seloing party is not considered to have disposed the property until the related buying party disposes of it to an unrelated party in a fully taxable transaction. E.g., not to another related party or in a §1031 transaction.

In the §1031 context the new, exchanged for property has carryover basis and a carryover holding period that is referenced to the activity that generated the suspended passive losses.

So in either case it is not a question of not meeting the "fully taxable" requirement causing the losses to remain suspended, but rather the lack of meeting the complete disposition requirement.

Additionally, if it were the fully taxable requirement that was not being met in your example, that would cause a disconnect in definitions. That is, §121's "fully taxable, but excluded" situation means "fully taxable" for §469(g)(1)(B) purposes, but §1031's "fully taxable, but deferred" means "not fully taxable" for §469(g)(1)(B) purposes.

In this thread's case I am stating that there is no support (code, regs, notices, PLRs, case law, etc.) for the contention that "fully taxable, but excluded from gross taxable income" has the same meaning as "fully taxable and included in gross taxable income".

PVVCPA (talk|edits) said:

February 25, 2007
Allow me to attempt to muddy the water.

Here is my summary of §469(g): A complete disposition in a fully taxable transaction will cause all suspended passive loss from that activity to be treated as not from a passive activity.

Here is my interpretation of §469(g): You cannot free up all of the suspended losses on a property unless the property is sold in a fully taxable transaction. And I agree that, a fully taxable transcation is a sale where all of the realized gain is also recognized.

But my interpretation is different than what I am hearing in the prior posts. The prior posts are saying that none of the suspended losses can be freed up, unless there is a fully taxable transaction.

Do you see the difference?

§469(g) is not saying that none of the suspended losses can be freed up. It is saying that you just can't free up all of the suspended losses.

If my interpretation is correct then using PGattoCPA's example above, the taxpayer would have have a $15K recognized gain after taking Sec 121 exclusion, a $10K Sec 1250 recovery, offset by $25K of suspended losses. $50K would remain suspended.

Solomon (talk|edits) said:

25 February 2007
Discussion:Sale of Passive Rental Yet Home Qualifies for Sec 121 Exclusion.

Solomon (talk|edits) said:

25 February 2007
Discussion:Passive loss carryovers when prop converted to personal residence. See last two posts in this discussion.

PVVCPA (talk|edits) said:

February 25, 2007
Solomon, neither of those threads discuss this topic to the degree that has been discussed in this thread.

I am interested to hear a reply to my post from prior participant's to this thread.

ScottCPA (talk|edits) said:

25 February 2007
sorry if i haven't read every post here - but isn't it as simple as this: you are basically selling 2 properties, 1/2 of the sale is a sec 121 transaction, and the other 1/2 is a sale of a passive rental property - and since you are reporting the rental property portion sale as a "fully taxable transaction", then any PAL carryforwards would get to be deducted. I just don't see where the nontaxable 1/2 (being a sec 121 property) has anything to do with the the taxable 1/2.

PVVCPA (talk|edits) said:

February 25, 2007
ScottCPA, the discussion has changed to a discussion about whether or not you can free up a suspended PAL if the taxpayer has a recognized gain in excess of the Sec 121 exclusion.

Read my long post dated 2/25/07 to see what the current discussion is about.

Solomon (talk|edits) said:

25 February 2007
Other threads - thought Riley2's comments regarding "recognition" of 121 income was germane to PAL.

Solomon (talk|edits) said:

25 February 2007
From ATG:
The following are not fully taxable:
   * Like-kind exchanges.
   * Conversion to personal use.
   * Transfer to a corporation or partnership.
   * Transfer due to divorce (treated as gift-IRC § 469(j)(6) & § 1041(b).
   * Installment sale (PALs triggered in ratio to gain reported).

PGattoCPA (talk|edits) said:

25 February 2007
We would need to see what Riley2's comment "all gain is recognized (as defined in the Code)" means (i.e., what part of the Code) in the thread "Discussion:Sale of Passive Rental Yet Home Qualifies for Sec 121 Exclusion" linked to above will nullify what I say below. I say this because as I quoted above in this thread, the legislative history of §121 (in the Committee Report for PL 105-34 which enacted the revisions to §121) says the following when referring to the (then) present law:


"No gain is recognized on the sale of a principal residence if a new residence at least equal in cost to the sales price of the old residence is purchased and used by the taxpayer as his or her principal residence . . ." and in referring to the (then) one-time exclusion, "an individual, on a one-time basis, may exclude from gross income . . ."


So we have under the former law support for the contention I am making. That is, the gain is not recognized, but excluded. It is simply not recognized.

What about current law?

In the explanation of the new provision the committee report states, "Under the bill a taxpayer generally is able to exclude up to $250,000 ($500,000 if married filing a joint return) of gain realized on the sale or exchange of a principal residence. The exclusion is allowed each time a taxpayer selling or exchanging a principal residence meets the eligibility requirements, but generally no more frequently than once every two years. The bill provides that gain would be recognized to the extent of any depreciation allowable with respect to the rental or business use of such principal residence for periods after May 6, 1997."


Please note how the words REALIZED and RECOGNIZED are being used above. The amount that is excluded,and therefore not taxable, is referred to as the REALIZED gain whereas the amount that is not excluded, and therefore taxable, is referred to as the RECOGNIZED gain.

So once again, the portion that is not taxable is realized, but excluded while the portion that is taxable is realized and recognized.

PVVCPA (talk|edits) said:

February 25, 2007
PGatto, I agree with you regarding the definition of fully taxable.

But I would like for you to address what I brought up in my prior post. Allow me to repeat it here:


Here is my summary of §469(g): A complete disposition in a fully taxable transaction will cause all suspended passive loss from that activity to be treated as not from a passive activity.

Here is my interpretation of §469(g): You cannot free up all of the suspended losses on a property unless the property is sold in a fully taxable transaction. And I agree that, a fully taxable transcation is a sale where all of the realized gain is also recognized.

But my interpretation is different than what I am hearing in the prior posts. The prior posts are saying that none of the suspended losses can be freed up, unless there is a fully taxable transaction.

Do you see the difference?

§469(g) is not saying that none of the suspended losses can be freed up. It is saying that you just can't free up all of the suspended losses.

PGattoCPA (talk|edits) said:

25 February 2007
PVVCPA: Let me see if I understand when you say, "If my interpretation is correct then using PGattoCPA's example above, the taxpayer would have have a $15K recognized gain after taking Sec 121 exclusion, a $10K Sec 1250 recovery, offset by $25K of suspended losses. $50K would remain suspended."

I think you mean my second example where the §121(f) election is made and there is no exclusion of the $15,000. In re-reading my example, I agree with you and think I did a cut and paste of the first example without the required edit. That is, if the $15,000 capital gain is not excluded and, therefore, recognized an additional $15,000 of the suspended passive losses would be deductible and offset the $15,000 capital gain. This would leave, as you correctly point out, $50,000 of suspended passive losses.

Apologies for my incorrect example. Thanks for pointing it out.

No, really. Thanks for pointing out my mistake.

Really . . . Image:smile.jpg

PVVCPA (talk|edits) said:

February 25, 2007
PGattoCPA, to be honest I did not realize that you had made the mistake. I misread your post, and was arguing a whole different point.

Here is the point I wanted to bring up. To discuss it, I need to make the following change to your example:

Let's say that the single taxpayer had a $265,000 realized capital gain. They did use the Sec 121 exclusion of $250,000 against that, resulting in a recognized gain of $15,000. (Let's ignore Sec 250 recovery for now).

Would they be able to free up $15,000 of the suspended $75,000 PAL? I believe so.

This property is a "former passive activity" as defined in §469(f).

And §469(g) merely says that you cannot free up the entire PAL unless the disposition is a "fully taxable transaction". §469(g) does not prohibit a partial release of the suspended PAL.

PGattoCPA (talk|edits) said:

26 February 2007
PVVCPA: I agree with the conclusion of your example - I think, though, for a different reason. An activity does not have to be disposed of to utilize suspended losses. Suspended passive losses can be utilized to the extent of current year net passive income. So in your example we do not even have to consider the "extent" of the disposition; that is, there is $15,000 of current year net passive income so $15,000 of suspended passive losses can be utilized.

I think you and I are on the same page in the big picture with respect to §469 and suspended losses, but I want to think about a specific example that addresses your concerns and where we would agree for the same reason!

PVVCPA (talk|edits) said:

February 27, 2007
I use PPC for some research. In Section 16D of their 1040 Deskbook they say that the sale of residence utilizing a Sec 121 exclusion that was formerly a rental property is not sold in a fully taxable transaction and therefore NONE of the suspended losses can offset any RECOGNIZED gain and ALL of the suspended losses must continue to be carried forward.

Do you agree with me that they are wrong?

PGattoCPA (talk|edits) said:

27 February 2007
From the way you describe it, I agree with you that PPC's conclusion is wrong.

And in thinking about examples, I believe we have already covered the waterfront. That is, we've covered what happens if there is:

1) a complete and fully taxable disposition;

2) a complete, but partially taxable / partially excluded disposition; and

3) not a disposition at all, but current year net passive income that suspended passive losses can offset.

PVVCPA (talk|edits) said:

February 28, 2007
Domo arigato, Mr. PGatto.

Jackibees (talk|edits) said:

4 June 2010
I know this is a very old thread, but I am currently working on a situation where I need to determine if a 121 transaction is a fully taxable transaction. My gut instinct was no, however, I'm not finding anything that specifically says that 121 calls for the nonrecognition of gain (even though it practically has that effect.) I know Soloman (in a prior past) said that 121 transactions are fully taxable. Does anyone have any authority that they can point me towards for this issue?

Seaside CPA (talk|edits) said:

4 June 2010
I agree with the above posts that a sale that falls under Section 121 is fully taxable, however you can exclude up to $250,000/$500,000 of gain. You can, however, elect to have the gain exclusion rules NOT apply per IRC Sec. 121(f), and recognize all gain.

RoyDaleOne (talk|edits) said:

4 June 2010
This is an old posting, however, I think I disagree with most of the discussion in the original fact pattern about PALs. Also disagree with the use of some of the terminology.

Jackibees (talk|edits) said:

8 June 2010
Is there any authority anywhere that points out that excluded gain is not unrecognized gain? I have a taxpayer who excluded $15,000 of gain under 121 and is trying to convert his passive activity losses on the property (it was used for a rental property for 2 of the last 5 years) to nonpassive losses to apply against ordinary income. Our initial treatment of the transaction was that the 121 transaction is not a "fully taxable disposition" therefore the passive activity losses cannot be converted under 469(g), however, I'm wondering if the losses could be converted if there's a way that I can show that excluded gain is still realized and recognized gain. Do you have any thoughts?

Re: 121 and "fully taxable transaction," see Discussion:Passive Losses When Section 121 Is Used.

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