Do you lose passive income loss?

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bac573
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Do you lose passive income loss?

Post by bac573 »

We've owned a beach rental property for a year. Due to renovations and our purchasing basis, we had a $15,000 passive income loss carryover for 2019. Assuming we break even in 2020, if we sold our current primary home and moved into the "rental" property in 2021 and made that property our permanent residence, what happens to the $15,000 of passive income loss? Do we just lose it? We would have no other passive income gains to be offset by the $15,000 lose. Thanks.
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dstac
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Re: Do you lose passive income loss?

Post by dstac »

You don't lose it, but my understanding is that it stays suspended - effectively waiting for you to get passive income to offset.

However, there are also some complicated things around your eventual disposal of your new home. Typically if you were just selling the rental, the losses could be captured as part of the sale, lowering your tax burden. However, these details are beyond my knowledge. My simplification is that you'll want to still hold on to those loss records and continue to carry them forward.
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FiveK
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Re: Do you lose passive income loss?

Post by FiveK »

Have you looked at Form 8582, Passive Activity Loss Limitations? In particular, p. 3 of https://www.irs.gov/pub/irs-pdf/i8582.pdf: "If you actively participated in a passive rental real estate activity, you may be able to deduct up to $25,000 of loss from the activity from your nonpassive income."

Does that apply to you?
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LadyGeek
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Re: Do you lose passive income loss?

Post by LadyGeek »

This thread is now in the Personal Finance (Not Investing) forum (taxes).
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2babogle
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Re: Do you lose passive income loss?

Post by 2babogle »

No. You can take that when you sell the property though.
MarkNYC
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Re: Do you lose passive income loss?

Post by MarkNYC »

bac573 wrote: Tue Jul 21, 2020 2:46 pm We've owned a beach rental property for a year. Due to renovations and our purchasing basis, we had a $15,000 passive income loss carryover for 2019. Assuming we break even in 2020, if we sold our current primary home and moved into the "rental" property in 2021 and made that property our permanent residence, what happens to the $15,000 of passive income loss? Do we just lose it? We would have no other passive income gains to be offset by the $15,000 lose. Thanks.
Without any other passive income, the passive loss carryover goes forward until the property is fully disposed of, at which time the loss can be deducted.

Whether you or someone else prepares your tax return, I would suggest the following. After moving into the former rental property, you should continue to prepare page one of Schedule E each year until the property is sold, even though you no longer operate a rental property. You can change the property description of line 1a of Schedule E to: "123 Main St -Not in Service" or something similar. This will explain why there are no numbers each year on Schedule E until the year of sale. If Schedule E is deleted when the rental property ceases, many tax programs will also delete the associated Form 8582 which keeps track of the loss carryover, in which case the loss will either be forgotten many years in the future or the loss will be awkward and difficult to list on the return and justify in the year of sale if it does not appear anywhere on the tax returns in the recent years prior to the year of sale.
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Re: Do you lose passive income loss?

Post by grabiner »

MarkNYC wrote: Tue Jul 21, 2020 8:24 pm Whether you or someone else prepares your tax return, I would suggest the following. After moving into the former rental property, you should continue to prepare page one of Schedule E each year until the property is sold, even though you no longer operate a rental property. You can change the property description of line 1a of Schedule E to: "123 Main St -Not in Service" or something similar. This will explain why there are no numbers each year on Schedule E until the year of sale. If Schedule E is deleted when the rental property ceases, many tax programs will also delete the associated Form 8582 which keeps track of the loss carryover, in which case the loss will either be forgotten many years in the future or the loss will be awkward and difficult to list on the return and justify in the year of sale if it does not appear anywhere on the tax returns in the recent years prior to the year of sale.
You will also need this for other recordkeeping purposes. When you sell the house, you may be able to exclude the capital gain on sale of your primary residence, but you cannot exclude the capital gain from the time it was a rental. If the property's basis was $200K when you moved into it, and its current value is $300K, that $100K will become taxable upon sale (but this will also free up an offset of passive losses).
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Re: Do you lose passive income loss?

Post by MarkNYC »

grabiner wrote: Tue Jul 21, 2020 9:02 pm You will also need this for other recordkeeping purposes. When you sell the house, you may be able to exclude the capital gain on sale of your primary residence, but you cannot exclude the capital gain from the time it was a rental. If the property's basis was $200K when you moved into it, and its current value is $300K, that $100K will become taxable upon sale (but this will also free up an offset of passive losses).
The calculation of the non-excludable portion of the capital gain is not done that way.

Let's say the house was bought for $200K and rented for 2 years with $10K of depreciation, then with a FMV of $300K converted to a principal residence and lived in for 18 years then sold for $400K. There is a gain of $210K, of which $10K is attributable to depreciation and is not eligible for the exclusion. Of the remaining $200K gain, 10% or $20K is not eligible for the principal residence exclusion because only 10% (2 of the 20 years) of the ownership years is considered nonqualified use. So the amount of the gain not eligible for the exclusion is based on an ownership-period ratio rather than the FMV at the time the property is converted from a rental to a principal residence.
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bac573
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Re: Do you lose passive income loss?

Post by bac573 »

Thank you all for the responses, very helpful.

FiveK, that does not apply to us.

MarkNYC, thank you very much for the suggestion
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rtom
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Re: Do you lose passive income loss?

Post by rtom »

Regarding MarkNYC's calculation:
MarkNYC wrote: Tue Jul 21, 2020 10:03 pm Let's say the house was bought for $200K and rented for 2 years with $10K of depreciation, then with a FMV of $300K converted to a principal residence and lived in for 18 years then sold for $400K. There is a gain of $210K, of which $10K is attributable to depreciation and is not eligible for the exclusion. Of the remaining $200K gain, 10% or $20K is not eligible for the principal residence exclusion because only 10% (2 of the 20 years) of the ownership years is considered nonqualified use. So the amount of the gain not eligible for the exclusion is based on an ownership-period ratio rather than the FMV at the time the property is converted from a rental to a principal residence.
If they had lived in the home first and then rented it, would the calculation still be the same? I believe that makes a big difference, right?
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Re: Do you lose passive income loss?

Post by MarkNYC »

rtom wrote: Fri Jun 24, 2022 10:06 am Regarding MarkNYC's calculation:
MarkNYC wrote: Tue Jul 21, 2020 10:03 pm Let's say the house was bought for $200K and rented for 2 years with $10K of depreciation, then with a FMV of $300K converted to a principal residence and lived in for 18 years then sold for $400K. There is a gain of $210K, of which $10K is attributable to depreciation and is not eligible for the exclusion. Of the remaining $200K gain, 10% or $20K is not eligible for the principal residence exclusion because only 10% (2 of the 20 years) of the ownership years is considered nonqualified use. So the amount of the gain not eligible for the exclusion is based on an ownership-period ratio rather than the FMV at the time the property is converted from a rental to a principal residence.
If they had lived in the home first and then rented it, would the calculation still be the same? I believe that makes a big difference, right?
Yes, if the residence period comes first and the rental period comes last, the calculation is different. The rental period would be limited to 3 years in order to satisfy the 2-out-of-5 years use requirement at the date of sale, and the portion of the gain attributable to rental depreciation would not be eligible for the exclusion. But all of the remaining gain would be eligible for the exclusion because there would be no period of nonqualified use.
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Re: Do you lose passive income loss?

Post by rtom »

MarkNYC wrote: Fri Jun 24, 2022 4:35 pm Yes, if the residence period comes first and the rental period comes last, the calculation is different. The rental period would be limited to 3 years in order to satisfy the 2-out-of-5 years use requirement at the date of sale, and the portion of the gain attributable to rental depreciation would not be eligible for the exclusion. But all of the remaining gain would be eligible for the exclusion because there would be no period of nonqualified use.
[ quote fixed by admin LadyGeek]

A bit off-topic, but I will ask here anyway:

Would this also be true if an owner is eligible for a partial section 121 exclusion?

For example, let us say a home is used as a primary residence for 12 months, and then rented out for 24 months, and then sold. And the reason for renting it out was that an involuntary job loss occurred, followed by the need to move to a new distant job. In this case I have been informed that it reasonable to say that a partial section 121 exclusion of the gain would apply, that max exclusion being (12)($500K)/(36) = $166K.
Last edited by LadyGeek on Sun Jun 26, 2022 12:47 pm, edited 1 time in total.
Reason: Fixed quote
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Re: Do you lose passive income loss?

Post by MarkNYC »

rtom wrote: Sun Jun 26, 2022 11:29 am
MarkNYC wrote: Fri Jun 24, 2022 4:35 pm Yes, if the residence period comes first and the rental period comes last, the calculation is different. The rental period would be limited to 3 years in order to satisfy the 2-out-of-5 years use requirement at the date of sale, and the portion of the gain attributable to rental depreciation would not be eligible for the exclusion. But all of the remaining gain would be eligible for the exclusion because there would be no period of nonqualified use.
[ quote fixed by admin LadyGeek]

A bit off-topic, but I will ask here anyway:

Would this also be true if an owner is eligible for a partial section 121 exclusion?

For example, let us say a home is used as a primary residence for 12 months, and then rented out for 24 months, and then sold. And the reason for renting it out was that an involuntary job loss occurred, followed by the need to move to a new distant job. In this case I have been informed that it reasonable to say that a partial section 121 exclusion of the gain would apply, that max exclusion being (12)($500K)/(36) = $166K.
The calculation for the issue of nonqualified use is different than the calculation for the issue of a partial exclusion.

A full exclusion requires at least 24 months of use/ownership, so for a partial exclusion 24 is the denominator, not the total months of ownership, which is 36 in your example. The numerator (with rare exceptions) would be the number of months of use as a principal residence. So for your example the available partial exclusion on a joint return would be 12/24 x $500K = $250K.

The portion of the gain attributable to the depreciation deducted for the 2 rental years would not be eligible for the partial exclusion.
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