Is sale of rental property at a loss considered capital or ordinary loss?

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?
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My understanding is that it is an ordinary loss. Rental gain/loss is computed on form 4797. Line 9 there says if you have a gain then report it Schedule D as a capital gain, and if you have a loss then go on and line 18b says to report on line 14.
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On 7/23/12 10:30 AM, removeps-groups wrote:

Not 100% correct. If you only have a loss from your rental property, then the loss will flow to Line 17. Line 18a tells you to enter the loss on the 4797 Line 17 on Line 28 of your Schedule A, Itemized Deductions. In other words, it becomes a misc. itemized deduction that is NOT subject to the 2% AGI limitation only if you elect to itemize your deductions. Line 18b only comes into place if you have other ordinary gains or losses in Part II of the 4797 and have to compute the gain or loss for Line 14 of the 1040.
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Alan
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My reading of Form 4797 is that only losses associated with casualty losses end up on Schedule A, Itemized Deductions. Can you show me where a normal loss on the sale of rental property (not associated with casualty losses) ends up on schedule A?
When this topic was discussed here a few weeks ago, it seems that people were saying that a loss on the sale of rental property was treated like any other capital loss - that is, it was subject to the $3000 annual limit on net capital losses. Based on what I have read the last few days and learned from testing a piece of tax software, it seems to me this is actually considered an ordinary loss which is fully deductible in the year of the sale.
The original discussion from a few weeks ago involved a rental condo sale resulting in a loss of roughly $50,000. Assuming the $50,000 loss is correctly calculated (the lower of FMV vs. original basis correctly used for start of the rental period, accumulated depreciation properly subtracted out, etc.), I'm thinking the full $50,000 loss can be deducted from the seller's income in the year of the sale. In other words, a loss on the sale of long-term rental property is not handled the same way as a gain on such sale. It is all ordinary loss.
Is that correct?
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On 2012/07/24 13:23, Rick wrote:

[...]
Actually, the OP in that discussion stated it was a capital loss, and asked if as such it would still be limited to $3K/yr against ordinary income. From there the discussion veered into the issue of basis, FMV, and other tangential issues.
Based on what I have read the last few

The instructions for Form 4797 include a chart on the first page that indicates where initial entries for various transactions are made, including Depreciable residential rental property Sold or exchanged at a loss Held more than 1 year.
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Mark Bole, EA
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This loss is a Section 1231 loss, and you can't tell whether it's going to be an ordinary loss or a capital loss until after you have combined it with all the other Section 1231 gains and losses - if any - on the taxpayer's return and done some other things, too. In this case, where there's only the one loss, it's almost certainly going to end up as an ordinary loss, but even that isn't totally certain. You might want to look up "nonrecaptured section 1231 losses" if you really want to get even more confused.
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responding to http://www.beansmart.com/taxes/is-sale-of-rental-property-at-a-loss-considered-capital-or-o-36756-.htm , saper_kd wrote: Your only option is capital loss as I understand your scenario. Rentals are considered an investment, not a business.
If you want to take a chance on being audited take the chance. Posters are working hard in my opinion at trying to take 100% of your loss in the year the property is sold and not limited to $1500 or $3000 depending on your filing status.
If you would like to check out the source of this comment and information and the information that the federal auditor uses go to www.irs.gov
search on: Passive Activity Loss Audit Technique Guide (ATG)
FORM 8582: Dispositions with Net Losses
If there is an overall net loss on disposition of a passive activity (after considering all current and suspended losses), none of the gains or losses should be entered on Form 8582.
Gains and losses from the sale should be reported on Schedule D.
Current and carryover losses should be reported on Schedule E in the non-passive column with a note to the left “Entire Disposition of Passive Activity”. If you have carry over loss because of MAGI limits you do report all these losses.
One thing I watch for... In the year of disposition was the home rented? often you no longer have a valid rental and do not get to take rental expense in the year of disposition. Example. Renter moved out in November 2012. You take the time to fix the house up, paint, new carpet, etc. and decide to put the home up for sale and no longer rent the home. The tax law has a lot to say as to what is a valid rental and this is another area that tax professionals often ignore as well as individuals. To have a valid rental you must prove that the home is available to be rented and that you are actively trying to rent the house. We check MLS listing!
I am an IRS auditor!
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I'm responding to the recent poster who described himself as an IRS auditor, and wrote "Your only option is capital loss as I understand your scenario" as a response to the OP.
He - the responder not the original poster - is quite simply wrong. The loss from the sale of a rental property can quite easily be an ordinary loss, and not limited to the $3,000 per year that a capital loss would be. His answer continues, and doesn't get any better as he continues. He seems to have never learned the Section 1231 rules. Maybe he slept during that class.
I will say, however, that the responder does show some other traits of being an IRS auditor, in addition to being wrong about the tax rules. Pushy, threatening, and know-it-all come to mind.
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On 1/30/14 8:36 AM, saper_kd wrote:

I don't know what you are reading. But you are completely wrong.
Here is what I read in the ATG from page 5-11, 5-12:
If there is an overall loss after current and suspended 5-11 losses are subtracted from net gain, nothing (neither gain nor losses) should be on Form 8582.
Here is what the instructions for the 8582 say:
Combine all income and losses (including any prior year unallowed losses) from the activity for the tax year to see if you have an overall gain or loss. If you have an overall gain, report the income, losses, and prior year unallowed losses on Worksheet 1, 2, or 3. If you have an overall gain and this is a former passive activity, report all income and losses (including any prior year unallowed losses) on the forms and schedules normally used and do not use Form 8582. If you have an overall loss when you combine the income and losses, do not use the worksheets or Form 8582 for the activity. All losses (including prior year unallowed losses) are allowed in full. Report the income and losses on the forms and schedules normally used.
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Alan
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I have decades of experience in tax preparation. I pride myself in being able to fill out IRS forms without using a computer. And here's the best advice about reporting gains and losses from the sale or taxable exchange of rental properties:
Use Form 4797, read the instructions very very carefully, follow the instructions very very carefully, and see if the results make sense. What you think might be a capital loss may easily - in fact likely will - turn out to be an ordinary loss. It depends on what else is on the tax return!
In my experience, this is much more helpful advice than *any* attempt to explain the "rules" of installment sale/non-installment sale ordinary/capital/section 1231/section 1245/section 1250/passive-nonpassive casualty/noncasualty gain/loss from the sale or exchange of business/investment personal/business depreciable/nondepreciable property. Do you see how many variables there are? An example just doesn't cut it.
An example is NOT SUFFICIENT to illustrate what rules are in play!!! Just use Form 4797 and follow the instructions, very very very carefully.
Oh yeah, *livestock* sale are different, too. And sales to a relative. And sales with a contingent selling price.
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