Tax Treatment of Loss on Condo Sale

What is the tax treatment on a loss from the sale of a rental condo?
We purchased a condo in January 2006 for my son to use while in college. After he graduated in 2009, we converted the property to a rental and have
been renting it out for the last three years. We are now in process of selling the condo at a huge loss with a closing date of August 1, 2012. That's also the date our tenant will be moving out. We are selling the unit for $85,000, some $70,000 less than what we paid for it.
At the start of the rental in 2009, we assumed the basis of the property to be $156,697. For tax years 2009 through projected 2012, our total depreciation expense will be approximately $18,282. Subtracting out the depreciation and the selling price, our net loss will be roughly $53,415. Is this loss treated like any other capital loss? That is, if all our other capital gains net out to zero each year, will we be taking this as a $3000 annual tax reduction for the next 17+ years?
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On 2012/06/20 12:14, JB wrote:

If I follow your math correctly, you used your adjusted basis as the basis for depreciation. You should have used the lower of fair market value (FMV) or adjusted basis. Just looking at the dates involved, without knowing the exact real estate market, it is unlikely that your basis for depreciation was lower than FMV, indeed it is highly likely that FMV was much lower.
The loss in value you undoubtedly experienced from 2006 to 2009 was personal loss and is non-deductible for tax purposes.
For tax years 2009 through projected 2012, our total

Give my comment above, it is likely that your loss on sale of the rental is actually much smaller than you are estimating. You cannot convert the non-deductible loss from the period of personal use to a deductible loss on rental real estate.
Otherwise, your comment is correct, only $3K of capital loss can be used each year to offset other ordinary income.
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Mark Bole
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You raise an interesting point about the depreciation basis, and it was an issue we considered when we put the unit into service as a rental. Since our unit had not been appraised since we originally bought it, we decided to look at comparable sales in the area to determine if the original adjusted basis was a valid number to use for fmv. It turns out that no other units in the building had sold during the prior two years (it is a relatively small building with fewer than 30 units). So I got a listing from the property appraisal site for the county of all the condos that had sold in the zipcode during the six months prior to the conversion, and I filtered the list to include only condos that were the same number of bedrooms and the same approximate age as our building (which was relatively new).
It turned out that in the six months prior to the conversion, there were seven such sales and the average selling price was 163,300. While all seven were larger than our unit in total square footage, they were the only one bedroom units sold during this time period which were a similar age to our unit. Interestingly, the one unit that was closest to us in square footage (only slightly larger than ours) and which coincidentally had sold during the same month as our conversion, sold for $210,000. On the basis of all this, we decided we had sufficient documentation to use our original adjusted basis as the approximate fmv for the depreciation basis.
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As a practical matter, is it even likely the IRS would challenge the depreciation basis after it had been recorded on the return for the prior three years (since 2009)? A $70,000 loss on the sale of property after three years isn't all that unusual - I know many people who have lost a lot more than that.
And in this particular case, is there any reason the IRS would question the taxpayer's documentation of how he calculated the FMV?
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On 6/21/12 1:50 PM, Rick wrote:

As with most situations, it's a question of (a) does this situation trigger and audit and (b) if audited for whatever reason, is this situation legit?
If we're to look at this scenario, I think the situation won't trigger the audit, but when they dig and see depreciation on the wrong starting numbers, the OP going to show his math. I also think it's our job to point out the correct answers, and if something is wrong, to suggest it be make right. This may mean 3 years amended returns.
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But in this case the taxpayer has a rationale for how he came up with the FMV for the start of the rental, using statistics on comparable sales in the area. Is the IRS really likely to challenge his FMV calculation? What else would the IRS expect the owner/landlord to do in this situation, if no other units in the building had recently sold? I would think that if the owner follows a logical, rational process to calculate the FMV using data from the county government, the IRS would probably give him the benefit of the doubt.
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On 6/21/12 3:40 PM, Rick wrote:

Sorry, I jumped in at the point where it seemed he started at a valuation higher than it should have been. If not, my bad.
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On 2012/06/21 12:40, Rick wrote:

Hopefully our answers in this newsgroup go beyond just what the odds of winning "audit roulette" might be.
>What else would the IRS expect the owner/landlord to do in > this situation,
Answer: get a professional appraisal.
I am not a professional appraiser, but of those appraisals I have seen, comparable properties are selected using more attributes than just zip code and number of bedrooms (if it was that simple, why would anyone ever hire a professional appraiser?) OP cites an average price, what was the median? OP says every one of the properties that he compared to were larger than his, but he made no adjustment for that. Also, I think it's common knowledge that property values depend heavily on items such as quality of school district, proximity to public transportation, whether the property is on a quiet residential street or in a busy commercial district, the available views from the unit, what the condo HOA fees and common amenities are (parking, pool, security), and so on. I would expect his amateur appraisal to take note of those factors as well.
It might be helpful in terms of this newsgroup discussion to provide the county where the property is located. If the overall real estate valuation in that county followed the pattern of the rest of the country, what extraordinary factors caused this particular property to go contrary to the trend -- retaining its value from 2006-2009 when everyone else was going down the tubes, and then somehow losing almost 45% value from 2009-2012 when everyone else was stabilizing or recovering?
Not a tax question, but from a financial viewpoint, I wonder what the OP was thinking when converting to a rental -- if the evidence was such that they could sell the property and break even in 2009, why not take advantage of that good fortune?
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That might be a good suggestion in hindsight, but at the time we didn't think it was worth the cost and effort to hire an appraiser just so we could come up with a better estimate of FMV on our taxes. Our thought was that since the average sale price of comparable properties was actually higher than our original basis, it was safe to use the original basis as the FMV for depreciation purposes.

The reason I would pay to hire a professional appraiser would be if I am buying or selling property and want to get an accurate assessment of its value. As someone who does not rent out property on a regular basis (this was the only time we ever did it), I didn't see the need to pay for an appraiser just to improve upon an estimate of FMV for a depreciation/loss calculation. If I rented out a lot of property or did this for a living, I might and probably would feel differently.
<< OP cites an average price, what was the median?
The median was 155,500, virtually the same price we used for the FMV.
<< OP says every one of the properties that he compared to were larger than his, but he made no adjustment for that.>>
Correct. When I looked at the data, there was no correlation between size of unit and square footage. In fact, the smallest unit in square footage sold for the largest amount. The fact that all of the units were larger was indeed an issue, but remember there were only six sales of comparably aged one-bedroom units during the period in question.

Those are all valid points, but in this case the sale prices for the six units were all roughly the same or very close to ours except for the one that was over 200K and which oddly was closest to us in square footage.
I should mention that our condo was unusual for its location in that it was a small one-bedroom unit in a building that was brand new when we bought it (and only three years old when we rented it). The vast majority of condos in the area were two bedroom units in buildings that were 20-30 or more years old. When I looked at comparable sales for the prior six months of one-bedroom condos in buildings that were 3 to 4 years old like ours, I only got these six results. When I searched for sales of one-bedroom units that were the same approximate square footage as ours in comparably aged buildings, there were none. When I expanded that search to include buildings that were up to five years older than ours, I only found three comparable sales and they also averaged out to approximately the same number we used.
But there's no point in getting into the weeds on this. My original post was not to ask if we could have improved on the FMV, it was to ask if the loss on the sale (whatever the amount) would be treated like any other capital loss. And more specifically I asked if all my other capital gains/losses netted out to zero each year, would I literally have to take this loss over a 17+ year period taking the maximum $3000 loss each year. I think the answer I saw from one respondent was yes, this is treated just like any other capital loss. That's really all I was trying to get from posting here. The discussion on FMV is interesting, but three or four years after the fact, I don't really see how I can improve on that number now.
> Not a tax question, but from a financial viewpoint, I wonder what the OP

>
It wasn't a financial decision per se. We held onto the unit because our son thought he might eventually want to move back in to attend graduate school, and might even eventually want to buy the unit. That didn't turn out to be the case. From a strict financial view point, we might actually be better off holding onto the unit and hoping it goes up in value, since we make enough money in rent to more than cover our expenses. But we are selling now because we just don't want the hassle of being landlords any more. As I said earlier, we don't do this for a living.
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The IRS is more likely to accept the opinion of a professional appraiser, though they don't always.
In your case it is possible to get an appraisal of a value on a specific date in the past, even if you did not get it at the time. Contact a qualified appraiser for more details.
___ Stu http://DownToEarthLawyer.com
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On 2012/06/24 17:35, JB wrote:

The "one respondent" who answered was me. I do try to actually answer the OP question in this forum before going off on other tangents. ;-)
I appreciate your willingness to share the other information. As a paid preparer, I was thinking through how I would handle this if you approached me to do your return, and I hope it was clear I was playing devil's advocate (due diligence) toward your data. It (the rental basis) is a problem that for many decades would have never arisen, as a significant drop in real estate values is a situation I believe most of us have not experienced until the most recent 4-5 year period. The need to determine FMV without an actual sale used to be a problem only for those who inherited real estate and wanted to know the stepped up (or down) basis.
As you continue to claim your capital loss carryover each year against ordinary income, be sure to keep all records related to your valuation. Although I don't think it likely, the IRS can audit the original claim of a capital loss well beyond the 3-year statute of limitations if you are still claiming the carryover on current returns.
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Mark Bole, EA
Enrolled Agents - America's Tax Experts
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On 2012/06/21 11:25, JoeTaxpayer wrote:

Agreed.
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Mark Bole
EA in CA
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