Inherited House – No Deductible Loss on Sale?

So you inherited a house, and decide to sell it to raise some cash for that trip around the world you’ve long been planning.  And depending on your circumstances, let’s assume that the fair market value at the date of the decedent’s death is your income tax basis.  But for any number of reasons, by the time the sale occurs you end up with a loss.  Your inclination would be to attempt to deduct the loss, but as in many areas of the tax law, your ability to convince the Revenooers that the loss is deductible may not be quite so “black and white” as you may think.

In rather old “Significant Service Center Advice” (issued by the IRS Office of Chief Counsel), the suggestion is that an estate generally may not deduct a loss incurred on the sale of a decedent’s personal residence unless it has been converted to an income-producing purpose before the sale takes place.  “We believe that the conversion of the decedent’s personal residence is not necessarily unusual, especially if the administration of the estate is prolonged.  Nevertheless, since the loss is only appropriately deductible if the estate can prove that the property was converted to income-producing property, estate returns should be examined on a case-by-case basis to determine whether the estate has converted the personal residence to rental property,” quoth the Counsel.

Under the relevant Internal Revenue Code section, losses are deductible only if arising from a trade or business, casualty or theft, or investment.

But what if the inherited property is not used for personal purposes (by the heir), nor is it intended to be used for such purposes?  It’s just put up for sale.  In this event, the record is replete with court decisions which do hold for the taxpayer – namely, that the property was acquired in a transaction entered into for profit.

And as you worry about whether or not you can deduct that inherited house loss, don’t spend all in one place those income tax savings resulting from your mortgage interest deductions.  Obama and his minions have more than once raised the specter of removing or limiting this one also, in the never-ending search for more “revenue.”  We hear that the deduction “cost” the Treasury somewhere between $80 and $103 billion in 2010, indicating that over a ten year period Uncle Sam could be about $1 trillion out of pocket from this item alone!

Recall that Obama’s Fiscal Commission proposed a 12% nonrefundable credit on up to $500,000 in mortgage debt, with no credit at all for a second residence or for home equity indebtedness.  And the Debt Reduction Task Force would go along with a 15% refundable tax credit, capped at $25,000.  And your president’s 2012 budget proposal suggested capping itemized deductions, including mortgage interest, for taxpayers in the top two tax brackets.

That would be all of you “wealthy” folks out there, who can surely afford to pay just a little bit more………

CONSULT YOUR TAX ADVISOR – This article contains general information about various tax matters.  You should consult your CPA regarding the implications to your own particular situation.

Jeff Quinn, the author of this article, is a shareholder in Ashley Quinn, CPAs and Consultants, Ltd., with offices in Incline Village and Reno.  He can be reached at 831-7288, welcomes comments at jquinn@ashleyquinncpas.com, and invites readers to consider his other commentary at http://blog.nolo.com/taxes/.