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I believe Joan is right with the dialog between taxpayer and auditor. What the auditor has done is limit the expenses to the extent of income (all expenses) which disallows a portion of mortgage interest, property taxes, insurance, utilities, depreciation, and repairs to the tune of about $16K in total. Also excluded is a carryover loss from the previous year with a resulting reduced carryover loss to 2011 which is not being audited but surely adjusted down the road. The audit result for 2010 is about $2500 in taxes and about $600 in penalties and interest. My guess is the impact on 2011 will be about the same if not a little more. Unfortunately, I was the preparer on this one and didn't think that the expenses could be limited since personal use didn't apply and the property, even though under repair and not rented, was still a rental/investment property so not limiting the expenses was reasonable. As such, I will probably take jainen's positon that the property remained a rental and the sales effort was merely an effort to see if their investment property could be sold at that time. By the way, I understand that the IRS was "audited" and the results indicated that 50% of rental property owners under/over-state income/expenses so efforts toward auditing rental properties will be stepped up. This must be part of that effort. I also saw that the IRS may disallow expenses if ythere is a loss for 3 or more years...much like the hobby rules. Really? I don't have a client who makes a profit on their rental properties because with both interest expense and depreciation create a loss every year. Do your cleints with rental properties generate income for tax purposes? What am I missing? By the way, I appreciate everyone's comments. Julie