PAL Carryover

[JackieCPA]

Hello!

I have a client who purchased a house - he put it into an LLC because the plan was to improve it enough to rent it out. However, he has decided a few years later to just sell it and not rent it out now that the improvements are done. I had originally set it up on the Schedule E with expenses as passive and had the loss carried forward (as there was no rental income). Now that he is selling it without it being rented at all, does he still qualify to take the passive loss that was carried with the sale or is that void since he decided not to rent it at all? The original plan was to have it rented - not sure if that matters or not. 

[Lee B]

The key question is, " Was the property  actually listed, advertised and available to rent ? "

If not, it was Investment Property.

[Corduroy Frog]

Either way, he will get the benefit of what has been spent.

However, if it is an investment, he will have Capital Gains (LT or ST, original post does not tell which)

If it is rental, the losses will accumulate and it should be an ordinary income loss reportable on Sch E.

 

[jklcpa]

20 hours ago, JackieCPA said:

Now that he is selling it without it being rented at all, does he still qualify to take the passive loss that was carried with the sale or is that void since he decided not to rent it at all?

He will definitely have basis of:

• original cost,
• settlement charges at purchase or paid outside of closing that are required to be capitalized, and
• any subsequent improvements

Then ...

The way the original post was worded, it seems that this property was never "put in service" as a rental, but it must have been entered on Sch E if PALs were reported.  I agree with cbslee that we need to know if it was available and advertised for rent.

If never put in service, he should have made an election to capitalize "otherwise deductible" expenses of the real estate taxes, mortgage interest, and other carrying charges that could have added to basis instead of incorrectly creating a PAL. For projects under development or unproductive real estate such as this one, the election must be made annually by attaching the election statement to the tax return by its due date including extensions.

In other words, IF it was never put in service as a rental and IF no 266 election was made for those years, I don't believe that there should be valid PALs available to help offset the gain, and I don't believe he would now be able to now add those expenses to basis for which no 266 elections were made.

 

Edited August 31, 2023 by jklcpa
clarified