Thinking about selling your personal residence for a loss? Think again before you rush into a sale. Most people are aware of the capital gains exclusion on the sale of a personal residence. If you sell your personal residence you may exclude up to $250,000 of your gain for single status filers and $500,000 of your gain for married filing joint status. What is often overlooked is the tax loss. Few taxpayers realize, until it is too late, that the loss on the sale of a personal residence is not allowed because your personal residence is not deemed an investment property.
To be considered an investment property you must move out of your personal residence and put it up for rent (yes, you must actually rent out your home for a reasonable period of time), thereby effectively establishing an intent to abandon the use of the property as your personal residence. Why must you go through this procedure? Because if your real estate is not your principal residence, it can be deemed an "investment property" and normal capital gains and loss rules apply. When your converted property is later sold, if a loss is recognized on the transaction you will most likely be able to deduct the loss as an (allowable) ordinary tax loss on Form 4797.
As with everything the devil is in the details so check with your CPA before employing this strategy because certain restrictions may come into play, e.g., when you convert your property to a rental property (income-producing use) you are supposed to use the lower of cost or fair market value (FMV).
Posted by Clint Coons, asset protection attorney, Seattle, WA