Ways to defray $50,000 loss on sale of home?

[lukebuz]

So, my primary residence I moved away from continues to sit with virtually no interest in it.  We dropped the price 3 times now, and it's at the lowest possible price I can stomach.  At this price, we will lose $45,000. 
Assuming the worst, and there is no interest in it - we may try renting it out.  This will at least cover the monthly interest loss and taxes, etc.
How long do you have to rent it out before you could try to sell it, and claim the losses as a tax deduction?
2 years?  5 years?  I've heard and read a few things, and none are clear.
We bought the house for $146K, dumped $40,000 into it, and now have it listed for $139K.  Big losses :(

[Cathy]

Good question, lukebuz.

The general rule is that "[t]here shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise". 26 USC § 165(a). However, in the case of individuals, deductions for losses are allowed only if the loss is of the sort described in 26 USC § 165(c). This includes (as relevant here) "losses incurred in any transaction entered into for profit". 26 USC § 165(c)(2).

The Secretary of the Treasury has prescribed a regulation that describes under what circumstances and to what extent the loss on your house sale constitutes such a transaction. 26 CFR 1.165-9(b). According to this regulation, when calculating the potentially deductible loss on the sale, the basis of the property is adjusted downward to "[t]he fair market value of the property at the time [that you started renting out the property]", if that is lower than what the basis would otherwise be. 26 CFR 1.165-9(b)(2)(i).

The consequence of this regulation is that, as far as losses go, when you change your property from your residence to a rental property, you in effect "lock in" the unrealised loss and no deduction for it is ever possible. You can only potentially deduct any further losses that occur after you start using the property as a rental.

[lukebuz]

wow.  bummer.
So, I guess it's just suck it up, and then cry myself to sleep.

[MacGyverIt]

Assuming the worst, and there is no interest in it - we may try renting it out.  This will at least cover the monthly interest loss and taxes, etc.
How long do you have to rent it out before you could try to sell it, and claim the losses as a tax deduction?

Is there a negative to renting, do you need profit to buy another place? Why not rent it out until you reach profitability?

I'm renting what was my primary residence. After expenses, to include my property mgr, I'm only make $200 on the condo but come tax filing time, at least the property mgr fees, HoA, property taxes, etc. are deductible business expenses.

If capital gains is an issue for you, here's what I'm planning if this helps spark some ideas. I ran calculations on when I would like to sell (by March 2019 to take advantage of no capital gains tax) and I'd barely cut even -- not enough padding to ensure profitability. So I'll likely continue to rent until 2022, move back into the place for two years so I can take advantage of the capital gains tax rule (must live in the residence two of the last five years prior to selling) and sell the condo in 2024.

[andyp2010]

Try breaking it up and renting it off in parts, its usually more profitable. I know of a place bought, rented out the rooms in the house, he rented out the garage AND carved off the land at the back with a fence and rented this out to an out of town building company as a temporary builders yard.

If it's cashflow positive, rent it out, if its feasible to do the above then go for it, good monies to be had

[Thegoblinchief]

I'm assuming you've already locked yourself into a new location.

Your option:

1. Stomach the loss. The house is listing for less than a 5% loss. The work you put into a house will almost never be a return on investment unless it's DIY. Your expected return should have been about half of that $40K. As real estate goes, this is actually quite tame. My house is currently 50% down from where I bought it and is a huge boat anchor keeping us here.

2. Rent it out and play the appreciation game. Will it cashflow at all? If it doesn't, you'll be losing money, just at a slower rate. Over the long-term it's probably best to cut and run, unless there's indication that the neighborhood is going to appreciate much faster than inflation. You've lost money, but right now it's a sunk cost. Probably best to take the loss and make it up in other investments.

Of course, if it does cashflow and works as an investment property (1% rule and all that) then keep it.

[Cathy]

If capital gains is an issue for you, here's what I'm planning if this helps spark some ideas. I ran calculations on when I would like to sell (by March 2019 to take advantage of no capital gains tax) and I'd barely cut even -- not enough padding to ensure profitability. So I'll likely continue to rent until 2022, move back into the place for two years so I can take advantage of the capital gains tax rule (must live in the residence two of the last five years prior to selling) and sell the condo in 2024.

To be clear, the rules for when losses can be deducted are completely unrelated to the rules for exclusion of capital gains from income on sale of a primary residence. These concepts are in separate parts of the Internal Revenue Code and are not related.

It also appears that you may misunderstand the capital gain exclusion rules. Moving back into the house for two years will not allow you to pay "no capital gains tax". Generally speaking, you will have to pay a prorated amount based on the percentage of time that the house was your primary residence since you purchased it (although periods before January 1, 2009 count as your residence for this purpose even if you weren't living there). For full details, see Kitces' article on this topic, which is well-written and contains many examples.

I blame the IRS for your misunderstanding about the capital gains exclusion rules. The IRS has never updated their publications regarding primary residence sales to contain the current law. This omission from IRS publications is legally irrelevant and does not change what rules are in effect, because IRS publications are not the law and cannot be relied on for any purpose. But the general public usually relies on these publications even though they are not legal authority, and it wouldn't be difficult for the IRS to avoid mistakes by updating their publications.

[Bearded Man]

According to the IRS publication if they do a 10-31 exchange and live in it for five years, they can exclude the capital gains, no?

[Cathy]

According to the IRS publication if they do a 10-31 exchange and live in it for five years, they can exclude the capital gains, no?

Not necessarily all of the gains. The pro rata rule (briefly described above) may still apply in this situation. Please read Kitces' article, and in particular his "Example 2d".

[Terrestrial]

So, my primary residence I moved away from continues to sit with virtually no interest in it.  We dropped the price 3 times now, and it's at the lowest possible price I can stomach.  At this price, we will lose $45,000. 
Assuming the worst, and there is no interest in it - we may try renting it out.  This will at least cover the monthly interest loss and taxes, etc.
How long do you have to rent it out before you could try to sell it, and claim the losses as a tax deduction?
2 years?  5 years?  I've heard and read a few things, and none are clear.
We bought the house for $146K, dumped $40,000 into it, and now have it listed for $139K.  Big losses :(

You should start looking at the money you already have in the place as a sunk cost....you're not really losing the money at this point, that money is already spent.   

At this point it matters little what you have into it and matters much more how to get out of it spending the least amount of additional money. 

[jwright]

According to the IRS publication if they do a 10-31 exchange and live in it for five years, they can exclude the capital gains, no?

You can't do a 1031 with a personal residence.  They would have to convert the current home to a rental, then exchange that home with a new rental or investment property.

[Mr.GrowingMustache]

I am almost in the same boat. I bought the house for $223k and probably put $10k in renovations. The bank evaluated the house for $180k ( I think I can get $200k but w/e).

Despite a $50k loss, I am still considering a sale because better properties around the area have also depreciated. So while I would be making a loss on the property I will also be getting a discount on a new property. To reduce sale losses I will also do a For Sale By Owner and reduce my sale "fees" from expected 10% (if I use a realtor) to about 5% (without a realtor) of the house sale value.

The situation sucks either way and I feel you, but if you are getting a $50k "discount" on a new and better house than it might make it less painful.

[Terrestrial]

I am almost in the same boat. I bought the house for $223k and probably put $10k in renovations. The bank evaluated the house for $180k ( I think I can get $200k but w/e).

Despite a $50k loss, I am still considering a sale because better properties around the area have also depreciated. So while I would be making a loss on the property I will also be getting a discount on a new property. To reduce sale losses I will also do a For Sale By Owner and reduce my sale "fees" from expected 10% (if I use a realtor) to about 5% (without a realtor) of the house sale value.

The situation sucks either way and I feel you, but if you are getting a $50k "discount" on a new and better house than it might make it less painful.

Good thoughts...this is almost exactly what I did - upgraded when the market was terrible to our 'ultimate' house, which I likely couldn't afford (or at least wouldn't have wanted to pay for) if I waited until the market full recovered to make me whole on the original place. 

I rented out the old house for a few years until the market came back enough that I could get out without writing a check (though still a loss from my purchase price) and sold it, mostly because it had some expensive maintenance items coming up in the next couple years and wasn't really making me much money from a cash flow perspective anyway.

All in all it worked out pretty well, if you can swing the down on the new place without selling the first one.  I got a much bigger price break from the highs on the twice as expensive house than i ended up losing on the first one.

[Fishindude]

Consider an auction with a bottom dollar reserve.
Sometimes buyers show up at auctions that wouldn't otherwise buy something that is traditionally listed.

[Bearded Man]

Man, almost makes me glad to live in an expensive area, how could your areas drop 50% in price or is this left over from 2007?