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Home value precludes tax loss

Published Oct. 4, 2005

(ran HP edition)

Patrick and Janis paid $325,000 for their home in 1984. They made several capital improvements, bringing its adjusted cost basis to $381,997.76.

In 1989, Patrick and Janis listed their home for sale at $399,000. But it didn't sell so they reduced the price to $359,000 and finally to $329,000. But no offers materialized.

They then lease-optioned their home at $295,000 to John. He paid $20,000 non-refundable option money and $3,055.79 monthly rent, with a $1,000 per month rent credit if he elected to buy the house at the option price of $295,000. In February 1990, John exercised his option and bought the house for $295,000.

On their federal income tax returns, Patrick and Janis claimed a tax loss on the property due to falling prices. However, the IRS denied the loss deduction. Patrick and Janis took their dispute to the U.S. Tax Court.

If you were the tax court judge, would you allow Patrick and Janis to deduct a tax loss on the difference between their $381,997.76 adjusted cost basis and their $295,000 sale price?

The judge said no.

Internal Revenue Code 165(c) does not allow deduction of any loss on the sale of the taxpayer's personal residence, the judge began. However, when a home is converted to rental status, its tax basis becomes the lower of the fair market value on the date of conversion or its adjusted cost basis, he explained.

Since the $295,000 option price was agreed upon on the date the house was lease-optioned to John, the judge emphasized, that is the best evidence of the home's market value when it was converted to rental status. Since $295,000 was also the sale price, Patrick and Janis have neither a tax loss nor a taxable profit, the judge ruled.

Based on the 1995 U.S. Tax Court decision in In Re Higgins, T.C. Memo 1995-193.

Robert J. Bruss is a nationally syndicated columnist on real estate.