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Discussion:Sale of residence converted to investment use

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Discussion Forum Index --> Advanced Tax Questions --> Sale of residence converted to investment use


Discussion Forum Index --> Tax Questions --> Sale of residence converted to investment use

Smokeytax (talk|edits) said:

28 February 2014
Client had a personal residence that they converted to investment use.

Cost was $200,000. Market value at conversion to investment use was $175,000. Property was sold a year after conversion to investment use for $180,000 BUT selling expenses were $15,000.

So, I'm coming up with proceeds, $180,000, cost basis $190,000 ($175,000 plus $15,000 selling expenses), deductible loss $10,000.

Is this correct? Am I overthinking the fact that the decline in value all took place during the period of personal use but we're still deducting a loss on sale of investment property?

Taxmonkey (talk|edits) said:

28 February 2014
How do you convert a house to investment use? Just stop living in it? Personally I am skeptical of this treatment, sounds like a second home and non-deductible personal loss to me.

Markb29 (talk|edits) said:

28 February 2014
I share Taxmonkey's skepticism.

Kevinh5 (talk|edits) said:

28 February 2014
me three

Ckenefick (talk|edits) said:

28 February 2014
No, you're 5

Smokeytax (talk|edits) said:

28 February 2014
Actually, I'm comfortable with the conversion to investment use. Client purchased a house in another state 4 years ago, but returned to the house in question & stayed there on occasion for work. But then, early 2012 client's employer moved her sales territory to another state so she didn't set foot in the house after that. She made a decision at that point to keep the house & hope for appreciation in value. She filed a declaration with the property tax assessors that the house was no longer being used as her residence, resulting in a doubling of her property taxes.

So, assuming the conversion to investment use will fly, any thoughts on my original question?

Kevinh5 (talk|edits) said:

28 February 2014
We still disagree, Smokey. It was a personal use asset. Never an investment.

Just because he doesn't qualify for homestead exemption, or primary residence tax rates, doesn't make it an investment.

DebP (talk|edits) said:

1 March 2014
Were you deducting the interest as investment interest expense? Or regular old Sch A mortgage interest?

Ckenefick (talk|edits) said:

1 March 2014
She made a decision at that point to keep the house & hope for appreciation in value.

From: George T. Doerries, TC Memo 1991-396 (a good case, which you should read...and it speaks to DebP's points as well):

However, the mere hope or expectation of gain does not automatically result in a conversion of a personal residence into property held for the production of income. Jasionowski v. Commissioner, 66 TC 312, 323 (1976).

And from JONES v. COM'R, Cite as 34 AFTR 601 (152 F.2d 392):

The improvements made were for the purpose and with the intent of making the land more salable and to minimize any loss thereon and were not made for the purpose of changing the use to which the property could be put and did not convert the transaction into one entered into for profit

Basically, it's saying that holding to minimize loss isn't the same as holding for profit.

Smokeytax (talk|edits) said:

1 March 2014
Thanks so much everyone for your input. Once again Tax Almanac saves the day!

EZTAX (talk|edits) said:

2 March 2014
"Were you deducting the interest as investment interest expense? Or regular old Sch A mortgage interest?"

I think this question raised by DebP above is the clincher (with great assist by Chris and others!)

Ckenefick (talk|edits) said:

2 March 2014
Maybe not THE clincher, but it is certainly very important..and also speaks to Monkey's comment about it likely being a 2nd Home. Many, many of these cases do dive into the, "How did the taxpayer treat it on his return(s)?"

The interest should have been treated as Inv Int and the RE taxes should have shown up as an Investment Related expense on the 4952.

And, don't forget, what about the Utilities, Lawn Mowing, Etc...did the taxpayer treat these as 2% deductions?

These are important considerations. And, if nothing else, this post brings these points home. If you ever have an isolated flipper guy that is angling for LTCG treatment, or a land holder who is doing the same, it would behoove you to use Form 4952 and put down the expenses on Schedule A even if they don't exceed the 2% floor (this is evidence)...or to make a Section 266 election in the case of land with a notation as to holding purpose. Go to the notary and get something signed to, even though the IRS will say it is self-serving...but what *isn't* self-serving?

Kevinh5 (talk|edits) said:

2 March 2014
Ice cream.

I've never seen 'self-serve' ice cream actually serve itself up to me. I always have to pull the handle myself to fill the cone.

Talk about a lack of truth in advertising.

Smokeytax (talk|edits) said:

2 March 2014
For 2012, not having the slightest idea as to whether the property would be sold a gain or at a loss, and the client having little prospect of investment income, we went ahead and deducted the $8K of mortgage interest expense as 2nd home interest. Honestly, I didn't even bring the issue up at the time.

So, if we want to assert that it had been converted to investment use Jan 2012, we'll have to go back & amend the 2012 return & pay tax related to the mortgage interest being characterized as investment interest, offset somewhat by deducting utilities and insurance as misc deductions, with the accompanying 2% of AGI and AMT issues. Plus, client will need an appraisal based on comparable sales as of the conversion date.

Now I'm wondering how much, if anything, I can charge the client for all of my futzing around on this question!

Ckenefick (talk|edits) said:

2 March 2014
Ain't that the truth. They probably stole the idea from gas stations.

Nilodop (talk|edits) said:

2 March 2014
Now I'm wondering how much, if anything, I can charge the client for all of my futzing around on this question!

"Origin of FUTZ - perhaps part modification, part translation of Yiddish arumfartsn zikh, literally, to fart around. First Known Use: circa 1930" (merriam-webster.com).

Smokeytax (talk|edits) said:

2 March 2014
Hah, Nilodop - that just about nails it.

STG (talk|edits) said:

2 March 2014
The IRS isn't stupid. You buy a home, you live in the home, you move out. You simply leave a perfectly good home empty as an "investment". That's just stupid. If it is an "investment", letting it sit empty and not attempting to rent it makes it the dumbest investment in history. It doesn't even pass the smell test.

They would have been better converting it to rental, asking too much rent or being too picky on renters, deducting all associated costs on Schedule E and then taking the loss (less accumulated depreciation. Still bulls**t, but at least it's normal bulls**t that is actually conceivable.

Ckenefick (talk|edits) said:

2 March 2014
The IRS isn't stupid.

You sure about that?

STG (talk|edits) said:

2 March 2014
Okay. You got me. But the IRS has a sense of smell.

Smokeytax (talk|edits) said:

2 March 2014
Good point STG. Hindsight, once the 2 out of 5 year period for excluding potential gain passed, I might have advised the client to do that. But, can't an investment in real estate be something you buy and hold, without renting, in anticipation of increases in market value?

STG (talk|edits) said:

2 March 2014
Maybe if it was land. It just doesn't make sense letting a residence sit empty for years. Maybe there's a situation where it makes sense, but that would be rare.

STG (talk|edits) said:

2 March 2014
And it certainly looks fishy if you lived in it for a while.

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