Capital loss on inherited house

[MoMMy]

I asked this in the Real Estate section, but nobody had anything to suggest, so maybe this is better as a "tax" question:

I need some real estate/tax help. My husband and his brothers inherited their father’s house in the UK in 2010 (we live in the US). The will required that the widow (not my husband’s mother) be allowed to live in the house. She died in 2016 and the house was sold soon after. Due to decline in the British pound, this was a $6000 capital loss. They had a rental agreement with the widow and she paid all expenses, but did not pay actual rent. Everything I read says that renting below market value is considered “personal use,” but legally they were required to do this, so my husband thinks it should be deductible as an "investment" property. Does the legal stuff factor into it at all? Or should we just be thankful that we don’t have to pay capital gains tax and move on? The IRS "help"-line was anything but. Thanks for any insight!!

[BlueLesPaul]

You would be correct that the property would appeared be considered personal use under the IRC because the rent was less than fair market value, but since the property was outside the US, the rules are probably more complex than they would be if the property was in the US. I would recommend talking with someone that is familiar with international tax issues before you just wrote off the $6,000.

If the property was located in the US, I am still unclear how this would all shake out.  Since the property is not your principal residence, but not strictly an investment property since the home was rented below fair market value, my assumption is that it would be treated in a similar manner to a second home and the loss would not be deductible.

[Drifterrider]

Your situation should be covered under "Life Estate".  That is the legal term used where I'm from in the US.  If the widow were entitled to "life estate" she was not a tenant.  The valuation might need to be set from her date of death, not from the date of the father, as the children did not directly inherit.  However, it has been 17 years since my accounting courses...........................

Search that term at irs.gov     Life Estate

[MoMMy]

Your situation should be covered under "Life Estate".  That is the legal term used where I'm from in the US.  If the widow were entitled to "life estate" she was not a tenant.  The valuation might need to be set from her date of death, not from the date of the father, as the children did not directly inherit.  However, it has been 17 years since my accounting courses...........................

Search that term at irs.gov     Life Estate

Thanks for this!! That's the sort of thing I was wondering about but didn't know what it might be called. I will go do some research.

[MoMMy]

You would be correct that the property would appeared be considered personal use under the IRC because the rent was less than fair market value, but since the property was outside the US, the rules are probably more complex than they would be if the property was in the US. I would recommend talking with someone that is familiar with international tax issues before you just wrote off the $6,000.

If the property was located in the US, I am still unclear how this would all shake out.  Since the property is not your principal residence, but not strictly an investment property since the home was rented below fair market value, my assumption is that it would be treated in a similar manner to a second home and the loss would not be deductible.

Thanks!! Yeah, I probably need an expert! Curious if others had dealt with this though. The best case is that we get to write this off, the worst case is that I can ignore it.

[Drifterrider]

Thanks!! Yeah, I probably need an expert! Curious if others had dealt with this though. The best case is that we get to write this off, the worst case is that I can ignore it.

Write what off? 

Edited:  What position does the UK tax authority take regarding value, taxes, etc? 

[MoMMy]

Thanks!! Yeah, I probably need an expert! Curious if others had dealt with this though. The best case is that we get to write this off, the worst case is that I can ignore it.

Write what off? 

Edited:  What position does the UK tax authority take regarding value, taxes, etc?

Sorry for my imprecise language, I meant "deduct the loss." He has already dealt with the UK tax authority. It was a small capital gain there, but tax was not due. He has all that documentation. My understanding is that the UK position is not relevant because he is a US resident (unless, e.g., he can take a foreign tax credit, which he can't). We are required to use USD as our functional currency, so on Form 8949 we definitely see a loss: If the house had been sold right when FIL died, we would have gotten $76K, but instead we got $70K. Interestingly, if it had been sold right when the widow died, we would have gotten $80K, but the pound tanked right after that.

I believe, as suggested by Drifterrider, the widow had a "life estate." But as she was never an owner of the house, it's unclear if the value would get stepped up at her death? More importantly, can we even deduct the loss since she had "personal use" of the house? When she died, can we argue that the house was then converted from personal use? Would it be considered "restricted property" before that time and hence it was not "vested" until she died? It was sold about a year later. If we had been able to sell it right after the father died, then my interpretation is that any loss is deductible if the heirs do not use it as a personal residence. I find no clear guidance on our situation though.

[Drifterrider]

Thanks!! Yeah, I probably need an expert! Curious if others had dealt with this though. The best case is that we get to write this off, the worst case is that I can ignore it.

Write what off? 

Edited:  What position does the UK tax authority take regarding value, taxes, etc?

Sorry for my imprecise language, I meant "deduct the loss." He has already dealt with the UK tax authority. It was a small capital gain there, but tax was not due. He has all that documentation. My understanding is that the UK position is not relevant because he is a US resident (unless, e.g., he can take a foreign tax credit, which he can't). We are required to use USD as our functional currency, so on Form 8949 we definitely see a loss: If the house had been sold right when FIL died, we would have gotten $76K, but instead we got $70K. Interestingly, if it had been sold right when the widow died, we would have gotten $80K, but the pound tanked right after that.

I believe, as suggested by Drifterrider, the widow had a "life estate." But as she was never an owner of the house, it's unclear if the value would get stepped up at her death? More importantly, can we even deduct the loss since she had "personal use" of the house? When she died, can we argue that the house was then converted from personal use? Would it be considered "restricted property" before that time and hence it was not "vested" until she died? It was sold about a year later. If we had been able to sell it right after the father died, then my interpretation is that any loss is deductible if the heirs do not use it as a personal residence. I find no clear guidance on our situation though.

You may have a reportable tax event for US taxes (gain): you may not.  In your case, considering all the factors, I'd consult a CPA knowledgeable in dealing with your particular situation.