loss on rental property sold.

You have quite a few years of rental use, and when you sell you will be recognizing a loss on Form 4797. You will also have less of a loss because of the amount of depreciation you claimed or should have claimed.

That's business loss, and not capital loss, so you are not going to be hit by an annual 3000 limit, if that's what you are asking. Although it's just possible with whatever else is going on there's a net operating loss, and that could complicate things.

Also in my opinion, Form 4797 is one of the most deeptive form around. It looks fairly simple, but might just produce a humongous amount of filing errors, and for that reason I'd recommend you seek professional assistance for the year of sale. From what you said, it might be best not to convert it back to personal use at all.

The starting number for computing any deductible loss is the lesser of the acquisition cost or the FMV on the date of conversion to rental (either one reduced by depreciation taken since then). In other words, if the property declined in value during the year of personal use, that decline does not increase a later deductible loss on sale.

And the allowed (which is the allowable, here) depreciation was based on the same figure.

Strictly speaking, depreciation is based on the cost basis allocated to the structure. You can't depreciate the land component of the property.

Ira Smilovitz

structure. You can't depreciate the land component of the property.

Thanks all. Just a quick follow up. Should we not move back into the house at all, for fear that it will then not be a rental property? Or do we have a year or two before that designation would kick in?

There is no waiting period. However, section 121 was amended in 2008 to limit the section 121 gain when you convert a rental into a primary residence. The 500k gain (if married) is limited by the a ratio that involves the number of years it was a rental to the total number of years you owned the house. This way you can't move into your vacation home and live there 2 years and sell it to take a 500k tax-free profit. You may read about it

the structure. You can't depreciate the land component of the property.

You should NOT move in. There's a whole mess of new rules to contend with when a property comes under mixed use in 2009 and later.

One thing to consider if you are thinking of moving in. If the market comes back and the value goes up, and you live in it for two years out of five, you'll be eligible for an exemption on your profit (currently $250,000 per owner). You will still have to recapture depreciation, however.

And will have to pro rate your exlcusion, which might of might not be a problem.