Selling a newbuild home at a loss - Can it be deducted?

[Ryan McGrail]

Jurisdiction

Massachusetts

I recently built a house in Danvers, MA that was meant to be a home for my family. During the build, my wife and I divorced. I am currently selling the house at a substantial loss. No one has ever lived in the house and it has never been a primary residence for any of us (or anyone else). Is it possible to deduct the loss on the house as an investment property? Or since it was meant to be a primary residence, it will be viewed as a residential property anyways. The loan was a construction loan that converted into a 30 year fixed.

Thanks for all your help.

 

[Tax Counsel]

You built the home as your personal residence and you cannot take a loss on property held for personal use. You never put the property in service as a rental or made any other business use of it so there is no rental/business deduction to take for it.

 

[PayrollHRGuy]

@Tax Counsel

Out of personal curiosity and maybe some help for the OP. How long would he need to rent the property for it to be considered business use?

 

[Ryan McGrail]

Appreciate the help, I didn't think I could take the loss, but it just doesn't seem right. Losing $150k and not being able to take the tax loss (at least vs. capital gains on other assets) is a big bummer. Thanks for the help.

 

[Tax Counsel]

@Tax Counsel

Out of personal curiosity and maybe some help for the OP. How long would he need to rent the property for it to be considered business use?

There is no set time for that, only that the circumstances are such that the taxpayer can show that there was a real intent to make a profit.

But the problem here is that conversion to rental/business use now would not help the OP deduct this loss. The rule that applies when there is a loss is that the basis used to determine the loss is the lesser of (1) the fair market value (FMV) at the time of conversion or the (2) the taxpayer's adjusted basis at the time of the conversion, which in this case would be the OP's cost basis. See page 11 of Publication 551 in the first column that discusses basis for the sale of property. Since the FMV now is clearly below the cost basis (which is why the OP is facing a loss) it would be FMV at time of conversion that determines the basis. Thus promptly turning around and selling it would result in very little, if any, loss to deduct. Thus rule developed for this very sort of situation: Congress did not want taxpayers to convert a nondeductible loss that had occurred while the property was held for personal use into deductible loss simply by converting it to a business use prior to sale.

Appreciate the help, I didn't think I could take the loss, but it just doesn't seem right. Losing $150k and not being able to take the tax loss (at least vs. capital gains on other assets) is a big bummer. Thanks for the help.

Of course that's a bummer. But the rule is the same for all personal use property. When you sell a car, TV, computer, furniture, household goods, or anything else that is personal use property at a loss you do not get to deduct that loss on your income tax return. The problem here is that you apparently either spent too much for the property and/or too much to build/renovate it. As a purely financial decision, that doesn't make sense and that's on you. Presumably you did what you did not for financial reasons but to make it the home you really wanted to live in. And that's fine, as long you understand that's what you are doing and that you may end up taking a loss (as you are here) later as result. It is not always guaranteed anymore, by the way, that homes will continue to appreciate significantly in value. Unless income increases keep pace, property values will hit a ceiling for what buyers can afford to pay for homes. Some areas of the country are already seeing home prices level off because of this.

Note that even if it had been deductible, it's a capital loss and you may only use capital gains to offset capital losses, except that you can deduct up to $3,000 of excess capital loss against ordinary income. So it might have been a very long time to recover that loss anyway.