What is the correct tax treatment of the sale of rental property at a loss? Is it considered ordinary income or a capital loss? A recent posting here suggests it is a capital loss, but other sites and even a piece of tax software I recently tested, suggest it is considered a business loss and therefore ordinary income.
Let's take a simple case. Taxpayer purchases a rental home in 2008 and sells it in 2012 at a loss of $40,000. The taxpayer never lived in the home or treated it as a vacation home or anything like that. The taxpayer is not a rental professional and this is the only rental property he has owned. He does not use a property manager or someone to collect rents, etc. - he manages the property himself. Assume he has taken the proper depreciation each year and that he has properly accounted for depreciation, improvements, etc. in computing the $40,000 loss.
Based on recent postings here and a few other sources, I assume this is a capital loss and in the absence of any other capital gains will be limited to a $3000 loss each year on the taxpayer's future returns. But other sites tell me this is an ordinary "Section 1231" loss and the full amount can be applied against the taxpayer's income and even carried back two years and ahead as a NOL.
Can someone explain to me the situations where the sale of rental property at a loss is considered a capital loss and when it is considered ordinary?