Help - need ideas for using up a large ($300k) capital loss carry over

[shingy]

Hey everyone - long time reader in need of some advice for a family friend of mine. Here are the details:

She got divorced a few years ago and in the settlement, she received the main house along with a rental property. Once finalized, she sold the main house and moved into the rental property. It so happened that upon selling the main house, there was a fairly large loss, about $300k. She claimed that on her taxes, which resulted in a huge carry over loss that rolls over each year.

She does not work and therefore doesn't earn much income, but there is enough for her to take the $3k/per year deduction against ordinary income. But, at that rate, she would never use the balance up in her life time. Furthermore, she does not have any other assets that currently have any unrealized capital gains. She will have some capital gains when she sells the property she moved into, but that will likely not exceed the $250k allowance everyone is entitled to.

Given this very unusual circumstance, we are trying to figure out ways for her to use up that carry over balance and get some real monetary value from it. So, I wanted to post about this and see if anyone has any good suggestions of what can be done to accomplish this.

Thank you!

[bacchi]

How is your friend claiming a capital loss from a personal residence?

[shingy]

Hmm - interesting question. Your post led me to do some searching and I see what you're referring to. I had no idea that wasn't allowed to be deducted - pretty bizarre considering taxes are owed on gains. Seems fair.. **eye roll **. 

But, even more odd is that this carry over does show on her return, so maybe there is some loophole or other nuance that her accountant used. I'll check into that to see what the deal is and will report back.

Thanks for your response, bacci.

[secondcor521]

The only way to use up a CLC that I know of is to realize capital gains.  Which you seem to indicate that she doesn't have any.

The only other idea is for her to find someone with a bunch of unrealized capital gains and marry them.  Not really a smart idea, obviously.

[mcneally]

I had no idea that wasn't allowed to be deducted - pretty bizarre considering taxes are owed on gains. Seems fair.. **eye roll **. 

Taxes aren't owed on gains up to $250k for a single or $500k for a couple on a primary residence (which you indicated knowledge of). Losses aren't allowed on personal use property for obvious reasons (imagine if you could buy a car for $20k then claim a loss when you sell it several years later for $5k, or when you buy $100 shoes then sell them at a garage sale for $2).

But, even more odd is that this carry over does show on her return, so maybe there is some loophole or other nuance that her accountant used.

One loophole is to report losses that aren't legally allowed.

She will have some capital gains when she sells the property she moved into, but that will likely not exceed the $250k allowance everyone is entitled to.

If the rental was purchased for say, $400k, then say in however many years as a rental $100k depreciation was taken so she has a basis of $300k, and it's fair market value when she moved in was $450k. The conversion to personal use is treated as a sale for tax purposes, so using my made up numbers she have $50k in capital gain that she could use some of the capital loss carryover against and $100k ordinary income.  If she used a new accountant when she began filing her single returns who rather than the same accountant who did the joint returns reporting rental activity, he may have been unaware this conversion took place.

Where does she live that a house went down in value $300k? Was it severely damaged and not covered by insurance?

[My thoughts as an IRS agent]

[The 585]

I would (and am) using CLC to convert an additional $3k Pre-tax -> Roth per year. Maybe that's an option.

[secondcor521]

I would (and am) using CLC to convert an additional $3k Pre-tax -> Roth per year. Maybe that's an option.

Sure, you can do that, but the two are not tied together in any real way.

A CLC offsets (up to) $3K of ordinary income each year.  Whether that ordinary income comes from wages, Roth conversions, or self-employment income doesn't matter a whit.

Said another way, if you didn't do the additional Roth conversion, the $3K CLC would still offset income; it would just be offsetting different income.  (Unless you don't have any other ordinary income to offset, which is sort of a corner case.)

[Sibley]

Without knowing all the details, my guess is your friend screwed up her taxes and shouldn't have any capital loss. Of course, since she does have a capital loss carryover that tells me that she's been using it to reduce taxes, at least a little bit. To fix everything, that would likely require amended tax returns for every year since the sale of the house. And that would likely result in some tax due for each year amended.