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Getting Personal: Categorizing a home sale that's lost money

A sign sits in the front yard of a home being offered for sale in Pleasant Prairie, Wis.

Tess Vigeland: We're back with tax accountant and enrolled agent Frank Degen to answer your questions as we barrel headlong toward April 18.

Bill joins us now from Alamosa, Colo.

Bill: Hi Tess.

Vigeland: So where are you in your tax preparation?

Bill: Well, I have a question.

Vigeland: Alright, Bill, my producer has just been whispering in my ear and I have to ask you this question: What do you do for a living?

Bill: I'm an accounting professor at a little four-year college.

Tess laughs

Vigeland: And not only that, but also...

Bill: Yes?

Vigeland: You used to have your own tax practice!

Bill: Well, I did. I'm actually a CPA. But that tax practice, I sold in 1986.

Vigeland: Tax law has changed just a little bit.

Degen: You're right.

Bill: I'm more of a tax advice seeker at this point.

Vigeland: Absolutely, and understandable. And Frank doesn't that just speak to how complicated our system is for everybody?

Degen: There's no doubt about it. This is not as easy as one, two, three. Very famous judge called Learned Hand, he served for many years on the Second Circuit Court of Appeals. And he has a tremendous quote. He said, "The tax code is a fantastic labyrinth whose words merely dance before my eyes in a meaningless procession. Cross reference to cross reference, exception upon exception." You can imagine the ordinary tax payer hearing that quote, and saying, "How can I do this on my own?"

Vigeland: Yup.

Degen: Simplifications easy to say, but very difficult to achieve.

Vigeland: Well, what can we help you out with today? What's your tax question?

Bill: My question is that three years ago, I moved from Illinois to Colorado and purchased a primary residence in Colorado. But I just sold my former residence in Illinois, which I had rented after I made the move. So since it was a rental property, my question is, can I take a loss on the sale and how much time does it take to establish that a former principle resident is now business property?

Vigeland: Oh boy. Frank, that sounds really complicated to me. I'm just going to hand it right over to you.

Degen: OK. Bill, let me just use a couple of numbers here. I don't know what your exact situation is, but listening to your conversation, I'm going to say that you bought a home, let's say $200,000. And then it dropped in value when you sold it, you lost money. Let's say you sold it for $150,000. So you had a $50,000 drop in value. Is that kind of what's going on?

Bill: That's about right.

Degen: Well, the thing is, as you indicated, when you have a personal residence, a loss on a sale of personal residence is not deductible. But I must say, as an aside, personal gains are taxable, so the tax law is somewhat in unfair in that respect. Then if you have a piece of rental property, a business asset, if you had a loss on that, then that is a tax-deductible event.

However, what you have to understand is, everybody would be -- if you could simply convert your house to a rental on a loss, everyone would be generating tax losses. So what the tax law says, is if you convert your personal residence into a rental property, the basis becomes for a loss, becomes the lower of the fair market value of the day of conversion. So using the example I gave you, if you bought it for $200,000 and you converted to a rental property when it's fair market value was $150,000, any loss is going to be measured from the $150,000, not the original $200,000 that you paid. Does that make sense Bill?

Bill: That does and I understand that you have a reduced basis as of the time of conversion. No, that makes sense.

Vigeland: Alright, well good question, hope that helps you out.

Bill: OK, thank you much Tess.

Vigeland: Thanks Bill.

Degen: Take care Bill.

Bill: Bye.

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