Sale of idle rental property

[Bilgerat]

Husband and wife placed rental property into service in 2011 and stopped renting in 2018.  Husband was too ill to deal with new renters and they decided to let it sit empty.  Husband passed away in 2021 and rental house was sold by wife in 2022.  They did not try to rent it but also did not use it personally.  It was never their principal residence.  Previous tax preparer stopped depreciation and recording expenses on sched e at the end of 2018.  I have the old depreciation schedule and can come up with allowed, allowable depreciation.  The surviving wife has an appraisal as of the date of death and I am stepping up her half of basis (non-community property state).  With the increase in basis it will be a loss situation unless no loss allowed.  So, would this be a regular sale of rental property with losses run through 4797? or  Sale of investment property with capital loss limited to 3K? or Sale of 2nd home with no loss allowed?  I keep going around and around on this one.  Thanks.

[jeffmcpa2010]

I'm having a hard time with the math, (1/2 FMV) Plus (1/2 of original cost) minus  (accumulated depreciation) Is less than current sale value ?

[rbynaker]

I don't know the answer but I'm surprised there's a loss with a 1/2 step-up in basis.

Basis for loss would be:

50% of original cost basis
-50% of accumulated depreciation
+50% of FMV on date of death

Can you share rough numbers?

Edit: Got distracted in the middle of writing this and didn't see Jeff's post, but sounds like we're on the same page!  The situation you describe is not impossible, just doesn't pass my sniff test.

[Bilgerat]

Cheapo rental.  They bought it at bankruptcy auction.  Original cost $58,932, $20,000 allocated to land, depreciable basis $38,932 .  Accumulated dep to end of 2018 was $10,441.  Surviving wife will have half of these.  The appraisal on the date of death is $148,270.  Her half of that step-up value is $74,135.  Her total basis is her original half $29,466 plus $74,135 half the FMV at DOD total of $103,601.  Allocation to land in her original half is $10,000 and $25,206 in step up half.  The surviving wife sold the rental for $75,000 in 2022.

[rbynaker]

Thanks.  Wow.  I would want corroborating evidence of FMV.  Appraisal at ~$150K and sale the next year for $75K sounds fishy.

I would likely go with capital loss on investment property.  Sounds like it ceased to be a rental when they stopped depreciation.

[Bilgerat]

Yes.  Appraisal is from legit licensed appraiser.  She just wanted to get rid of it and in her mind she sold it for a lot more than they paid and after receiving rent all those years.  I tend to think it is investment property since it was not held out for rent and I'll put it on sched d.  The accum dep as of the end of 2018 is what I plan to use to reduce basis.  Doesn't seem right to count depreciation all the way to date of sale in 2022 (allowable) if it was not being held out for rent.  There is no recapture if the house is sold as a loss.  The house could have been rented any time but they just didn't want to rent it.  Anyone have any other ideas, suggestions?

[BobKamman]

I would ask if the buyer was a relative or just a close friend.  Whatever the reason for the gift, I wouldn't claim a loss.  

[rbynaker]

I'm not questioning the legitimacy of the appraiser, just of the appraisal.  The IRS can point to hard evidence that the value of the property at time of sale was $75K (the value agreed upon between a willing buyer and a willing seller).  It's your uphill battle to show that the value on date of death was $148K only x months earlier.  Was there a reasonable county assessment you can point to?

[Bilgerat]

The person that bought the rental was a neighbor to the property in question. Taxpayer told me the neighbor had asked several years ago if it ever became available they wanted to buy.  Not a relative or related party to the best of my knowledge.  So, you would treat it like a 2nd home and not deduct any loss? Plug the basis to make it 0?

[Bilgerat]

rbynaker, you make some good points on the FMV between the willing buyer and seller (in this case only 3 months later).  Maybe this is a case when the gold standard is not an appraisal?  I'll check on county assessment.  Funny, I swear the people that would do nothing and report nothing would be right on this one.  Of course we can't do that.

[BobKamman]

There's no problem with the appraisal.  The seller made a gift to the neighbor.  She could do that because she had turned it into a personal-use item.  There's a way to report those on Schedule D to avoid claiming a nondeductible loss.  

[Bilgerat]

Bob, can you explain how to do that on sched d?  Are you saying she will need to do a gift tax return for the difference in appraisal and selling price?

[BobKamman]

You use the 1099-B worksheet even if there is no 1099-B.  Then you enter the nondeductible loss as the "adjustment amount" with a code L for the "adjustment code."  It should come out as zero gain or loss.  At least that's how I would do it, it's not worth spending a lot of time on because I'm not the one she favored with her generosity.

I'm not saying she needs to do a gift tax return because you didn't ask about that. 

[Bilgerat]

Thank you, Bob for your response.  That seems to be the substance of the transaction.