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When Does a Home Qualify as a Rental Property?

Apr 8th 2019
home rental
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Although you can’t claim a loss when you sell a home for less than what you paid for it, a loss from a home is sale may be deductible if the place is treated as an investment property. For that reason, taxpayers often convert their home into a rental property before selling it. However, as evidenced by a new case, Langston, TC Memo 2019-19, 3/21/19, the rental activity must be legitimate.

Of course, if you sell a home at a gain, you may qualify for a special tax exclusion of up to $250,000 for single filers and $500,000 for joint filers. The home must have been used as your principal residence at least two out of the previous five years. But there’s no corresponding tax break when you sell the home at a loss.    

For this reason, you might hold your home out as a rental property for at least two years before selling it. As a result, you may be able to deduct the loss.

In the new case, a couple owned a home in Tulsa, Oklahoma. It was appraised for $290,000 when they began remodeling it in 2001. They moved out of the home into nearby apartments in 2005 while the remodeling continued, but kept much of their belongings in the house for several years. In 2008, the couple moved into another home.

The remodeling was finished in 2010—nine years after it was started—but the house remained empty. For insurance coverage purposes, the couple found a friend who agreed to rent the house for five days per month at $500 per month.      

Finally, the couple offered the home for sale to the public in 2012 and sold it for $540,000 in 2013. Because of the remodeling, they claimed that the sale produced a $400,000 loss. They deducted this loss because they maintained that the home had been converted into a rental property.

Not so fast: The judge in the Tax Court case wasn’t buying their argument. To qualify as a rental activity, you must show intent to produce income from the property. It then is no longer treated as property for personal use. But that didn’t appear to be so in this instance.

The judge pointed out that the couple only put the property on the market for rent—and only for five days a month at that—to preserve their insurance coverage. The house was unoccupied during the prior years.  Thus, there was no real profit motive in this rental activity.  Plus, the taxpayers continued to use the house personally for storage.

Similarly, the judge dismissed the couple’s alternative argument that the property was an investment they intended to benefit from over time.

Bottom line: The home was never converted into a rental property, so the loss deduction is denied. The lesson to be learned here is that you can’t do things halfway. If your clients intend to use a home for rental purposes, they have to go all in.

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