The Tax Court has held that a married couple did not convert their secondary residence into property held for the production of income. Consequently, the taxpayers were not entitled to an ordinary loss deduction.
Take Away. Property is no longer treated as a residence when it is converted to business or investment property. As a result, gain as well as loss is recognized in the year of its disposition. Five factors, the court explained, are used to determine a taxpayer’s intent in converting a property, including offers to rent and offers to sell.
In 2004, the taxpayers purchased a condominium in an oceanfront community as a seasonal home. The taxpayers made some improvements to the condominium, such as installing new carpet, track lighting and custom closets. After the death of their daughter, the couple decided that they could no longer stay in the condominium. The taxpayers contacted a real estate agent to assist them in renting the property. A slow rental market eventually motivated the taxpayers to revisit their decision to rent the residence and they put the condominium up for sale. The condominium sold in 2010 for $725,000 (and the furniture in the residence sold for $80,000). The IRS and the taxpayers disagreed if the condominium had been converted to a property held for the production of income and if the taxpayers were entitled to an ordinary loss deduction on the sale of the property.
The court first found that no deduction is generally allowed for personal, living, or family expenses. However, an individual can deduct all ordinary and necessary expenses paid or incurred during the taxable year for the management, conservation, or maintenance of property held for the production of income. Whether property has been converted to one held for the production of income is a question of fact, the court noted.
Here, the court found that the condominium had not been converted to a rental property. The taxpayers had discussions with the real estate agent about renting the property but they never moved forward. The court characterized their efforts to rent the property as “minimal.”
The taxpayers testified that the real estate company featured the condominium in a portfolio in its office and would tell prospective buyers that it was available. The court further found that the taxpayers were not entitled to a deduction. This provision allows a deduction for any loss sustained during the tax year that is not otherwise compensated. For an individual to deduct the loss, it must be incurred in a trade or business, be incurred in any transaction entered into for profit, though not connected with a trade or business, or arise from some sort of casualty or theft. Additionally, the court upheld the accuracy-related penalty, finding that the taxpayers offered no evidence to show why the penalty should be removed
If you have any questions regarding the conversion of your property to rental and the related tax consequences, please do not hesitate to contact us.