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I read one post somewhere else that said: "The rule for a house is that if you have owned it for 2 out of the last 5 years and lived in it for two out of the last 5 years then it is a tax free sale, so you don't have to declare any gain, but you can't claim any loss either. So the house should do you no good, can't take a loss on your taxes. BTW the lived in and owned do not have to be the same years."

We owned and lived in it since 1999, moved in May 2010 and rented it out since then. Sold August 2012.

Everything I have read so far says we can take the loss on the sale of the rental house. I have NOT yet found anything about the "lived in it for two out of the last 5 years" rule mentioned in the above quote.

Does such a rule exist?
Thanks,
RB
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We owned and lived in it since 1999, moved in May 2010 and rented it out since then. Sold August 2012.

Everything I have read so far says we can take the loss on the sale of the rental house. I have NOT yet found anything about the "lived in it for two out of the last 5 years" rule mentioned in the above quote.


The quote, which is badly worded and incomplete and should be wiped from your memory, deals with the sale of a personal residence. If you had a gain it appears you would qualify for the primary residence exclusion. See Pub 523.

A loss on the sale of a rental property is deductible. But.... Given your timeline I'm having a hard time figuring out how you have a loss for tax purposes. Your gain/loss would be the net sale price minus your depreciated basis. If the property wasn't worth what you paid for it, plus improvements, your starting point for basis and depreciation calculations is its fair market value on the date you converted it to rental.

Phil
Rule Your Retirement Home Fool
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Thanks Phil.
We sold it for less than what we paid for it plus improvements. Funny, Turbo Tax didn't ask about FMV at time of conversion to rental. I'll look at it again.

I think I know what you are saying and will have to re-look at it. In essence, what you seem to be saying is that from 1999 to May 2010, any reduction in value due to the real estate market is NOT deductible because it wasn't a rental for those years.

So I take the FMV in May 2010, add improvements, subtract sales price and that will give me my gain/loss. Do I have that right?
Of course deciding on FMV can be tricky.

Thanks again,
RB
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I think I know what you are saying and will have to re-look at it. In essence, what you seem to be saying is that from 1999 to May 2010, any reduction in value due to the real estate market is NOT deductible because it wasn't a rental for those years.

Correct

So I take the FMV in May 2010, add improvements, subtract sales price and that will give me my gain/loss. Do I have that right?

You're getting closer. May 2010 FMV plus any improvement after that date, minus depreciation allowed or allowable is the basis part. You do get to consider the expenses of sale (commission, recording fees, etc.) in determining the net sales price.

Phil
Rule Your Retirement Home Fool
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So the tricky part is coming up with a FMV. That's quite a gray area, not set in stone. Realtors can't even really come up with the value of a house in current time, using comps, let a lone from 3 years ago.
It would be typical of them to say a range like, $130K to $170K but for tax purposes even $10K is a BIG difference. No one can estimate the FMV of a house that closely.
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So the tricky part is coming up with a FMV.

I'm going to stop dancing around the obvious and note that you didn't take care of business when you converted to rental, did you? That was the time you needed to ascertain FMV. Otherwise how would you be able to come up with a depreciable basis?

I strongly suggest that you hire help for your 2012 return. I did that when I sold a rental with a lot fewer complications than your situation. I have no special knowledge, but the people at the IRS aren't idiots, and I suspect they're well aware that a lot of homes were put into rental service after the market collapsed. This is easy pickings for them if you get it wrong.

For lurkers, to me going into the landlord business is just like going into any other buisiness. IMO it's downright foolish to do so without hiring some advice. Once everything's set up it's pretty simple until you sell, but in the beginning and the end, Accountant in a Box just isn't going to cut it.

Phil
Rule Your Retirement Home Fool
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So the tricky part is coming up with a FMV....

Hire an appraiser. Retroactive appraisals can be done. The FMV determined by an appraisal wouldn't be exact to the penny, but it'd be close, and certainly a defensible number for tax purposes.
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Is FMV only used when it is less than the purchase price and upgrades?

We are going to sell rental property in 2013. An EA prepared the return that setup the depreciation schedule. I need to review the tax returns, but I believe the purchase price minus value of the lot was used. At time of conversion to rental the FMV was greater than purchase price.
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Is FMV only used when it is less than the purchase price and upgrades?

Yes, and only when a personal-use property is being converted to rental. It stands to reason since losses on the sale of personal-use property aren't deductible, but losses on purely rental property are. Otherwise one could briefly convert to rental then sell and realize a tax loss largely incurred while it was a personal residence.

Phil
Rule Your Retirement Home Fool
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Basis of Property Changed to Rental Use

When you change property you held for personal use to rental use (for example, you rent your former home), the basis for depreciation will be the lesser of fair market value or adjusted basis on the date of conversion.
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No one can estimate the FMV of a house that closely.
The property tax assessor in my county estimates the FMV of EVERY house in the county that closely.
(And has to defend their estimate to owners who challenge the assessment.)

I think your point really was that it's possible for two different people to come up with two different estimates that are both valid. IMO the best thing you can do is get a professional (ie. RE agent or appraiser) opinion. Then if the IRS doesn't like what you use for a number, you can point to the documentation from the expert. (And if it's reasonable, the IRS probably won't bother beyond that point)
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Thanks guys. All good advice. Documentation is all important.
Thanks,
RB
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In WA State, where I am, the County Assessor is required to assess at 100% of full market value each year. It would seem that the IRS would have to go through a LOT of effort to disallow that figure.
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In WA State, where I am, the County Assessor is required to assess at 100% of full market value each year. It would seem that the IRS would have to go through a LOT of effort to disallow that figure.

Well, that would depend on how accurate the Assessor is. Kansas has the same requirement, and my father always played a game with the neighbors when the new assessed values were published in the paper, and the neighbors would start griping about how overstated the value (used as the starting point for tax assessments) was.

"Would you sell today for that much?"
"Hell, no. It's worth a lot more than that."

Not relevant to the sale process, but relevant to depreciation, is the land/improvements mix since land isn't depreciable. All hell broke loose in Northern Virginia a couple of years ago when many people with so-so houses in great locations found upwards of 75% of the total value allocated to the land.

Appraisal is an art, not a science, and that holds true for elected/appointed public servants as it does for private-sector appraisers. In my experience real estate agents have been the best source for a good idea of what a property will sell for today.

Phil
Rule Your Retirement Home Fool
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Marti,
While I understand and don'r disagree with what you said. We are talking apples and oranges. My point is how much effort any given IRS examiner might be willing to go to disallow a county assessor valuation. My thinking is that they would go to almost zero effort disallow such an assessment. So, if the figure is resonable, and you need a hard number from a third party, use it.
gsgreen
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My thinking is that they would go to almost zero effort disallow such an assessment.

Keep in mind that it takes almost zero effort to disallow pretty much anything on a tax return. All the auditor has to say is that figure is one used for property tax purposes and by it's nature does not necessarily reflect the FMV of the property.

The gold standard for FMV of real estate (short of an arm's length transaction) is an appraisal by a real estate appraiser.

I often request that my clients get an appraisal when the valuation amount is at all in question and the tax dollars involved justify the cost.

In my area, an appraisal costs about $400. The last client who needed an appraisal had over $10k of tax dependent on the appraisal. The appraisal fee was less than my tax prep fee. She was happy to get the appraisal for the peace of mind.

--Peter
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Once again. in Washington State, the real estate tax appraisal is, by law, fair market value and is backed up by sales comps in the county assessor's data base.
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Once again. in Washington State, the real estate tax appraisal is, by law, fair market value and is backed up by sales comps in the county assessor's data base.

I see. So no one in Washington State ever questions the real estate tax appraisal. It's always right. Got it.

--Peter
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My thinking is that they would go to almost zero effort disallow such an assessment.

Keep in mind that it takes almost zero effort to disallow pretty much anything on a tax return. All the auditor has to say is that figure is one used for property tax purposes and by it's nature does not necessarily reflect the FMV of the property.


In some areas, the real estate tax assessment does not have to reflect market value. For instance, in my area an assessment can remain unchanged as long as the average assessment for all property in the tax district is within 15% of FMV. Then there is Nassau County on Long Island. I'm not sure if this is still true, but it used to be that the assessment was based on the construction cost in 1936, regardless of when the structure was built.

Ira
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For instance, in my area an assessment can remain unchanged as long as the average assessment for all property in the tax district is within 15% of FMV.

Yep. And I'm in Prop-13-land, where your assessed value starts at your purchase price and can go up by no more than 2% each year.

--Peter <== currently a beneficiary of Prop 13
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And I'm in Prop-13-land, where your assessed value starts at your purchase price and can go up by no more than 2% each year.

BUT - it *can* go down below your purchase price (prop. 8)

And really the County Assessor still does a FMV valuation. They have to for prop 8 purposes. However, the amount you are taxed on - the "factored base year value" is only going up by 2%.

--foo1bar <== currently a beneficiary of Prop 8.
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Oh no. I myself have questioned/appealled the county assessors numbers several times. Always to get it reduced, of course. But the question was, where can one get a hard number to use as a FMV for something a few years back.
My position is that, in Washington State, one would be quite justified in using the assessor's numbers. Will it be absolutely correct down to the penny? Of course not. Will it be defensible if it ever came to an audit? Most certainly.
Even an independent appraisal can, and does, differ from one appraiser to the next. I have had appraisals re-done to get a different (better for me) number.
I never intended that my statements should imply that the county assessor's numbers should be the holy grail of appraisals. Just that they would be usable and defensible if needed.
Again, this is my opinion and is only in regards to the State I know - Washington.
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Again, this is my opinion and is only in regards to the State I know - Washington.

=====================================

You mentioned in a prior post that valuations have to be made every year. This is not true. They are every 4 years with a physical inspection once every 6 years.

Page one, column three

http://dor.wa.gov/docs/Pubs/Prop_Tax/HomeOwn.pdf

Changes to property values
Assessors must revalue real property at least once every four years. In
some counties, properties are revalued each year and require
physical inspection at least once every six years.


Some counties do make a change every year with a inflation rate. Ours does not. That 4 year valuation number can be quite a shock.

They can also use 3 different methods of valuation. (Also, page one, but column two) Which method they use can greatly vary the amount.

Jean
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Jean,
This is very true. I have houses in two different counties, one annual and one every four years. But again, what was the original question? How to get a valuation for several years ago. If you happen to be in a State like Washington where state law (and if we're going to pick nits, the State Constitution for Washington) says assessments are at 100% of FMV and you need a defensible, reasonable number, it's an easy way to go. It doesn't work for the current year, as assessments run a year behind. But for a time period from several years ago, it works for what the original questioner wanted.
I do believe we've beaten this horse way past death.
gsgreen
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