INFORMATION ON THE DISPOSITION OF A RENTAL BY SALE OR FORECLOSURE
Our firm charges a flat fee of $500 to report the sale of a rental. If you dispose of multiple rentals, this fee will be charged separate and apart for each property. We want to discuss the reason for this fee, the impact of the sale or foreclosure of a rental on tax liability and what is and what is not included in the $500 fee.
None of this information applies to a rental which is transferred by inheritance, gift or through a 1031 (like-kind exchange)
In the current depressed real estate market, rental dispositions frequently attract a great deal of attention from the IRS. This is because these transactions frequently result in dramatic reductions of tax liabilities and massive refunds. Especially where the client or clients have consistently earned too much each year (generally over $150,000) to deduct ongoing losses. These losses become "suspended" and are carried over from year to year, often accumulating to well over $100,000.
Under most circumstances, when the properties to which these carried over losses apply are either sold, or given up in a foreclosure (which under tax law is considered a form of sale) the entire amount of passive losses are "released," meaning they are allowed all at once. Imagine the impact on your normal tax liability if you were given a hundred thousand dollar discount. But that is not all.
In this market, most properties, unless they have been held in excess of ten years, will be sold at a loss. After allowing for the recapture of any depreciation the loss will more or less equal the sales price minus the client's investment in the property (the rules are different if the rental was converted from a personal residence). As with the suspended passive losses mentioned previously, this may result in an enormous loss. Unlike a capital loss, which usually is taken in only small pieces each year, the loss from the sale of a rental property may be taken in one lump sum, again offsetting ordinary income such as that from wages or retirement distributions.
The combination of the release of the suspended passive losses combined with the actual loss from the sale of the property may reduce or eliminate tax liability for any given year. Refunds exceeding $25,000 are not unusual if the right combination of circumstances is involved. Consequently, the disposition of a rental may result in a very high risk of an audit. We are well aware of this and take steps to ensure clients are aware what documents to keep to support the often huge refunds they receive.
Adding to the complexity of these issues is the shadow of cancelled debt. A short sale or foreclosure may result in additional income, again with the potential to be quite large, and which then acts as a counter-weight to the tax advatgaes of the release of suspended passive losses and the actual loss on the sale of the property.
If the property has been held for a longer period of time, or if the debt on the propertyy is non-recourse in nature, then a capital gain issue may arise requiring yet another analysis.
Our $500 fee takes all these factors into account. We determine the net effect of these various considerations, and do whatever further analysis might be necessary, especially where the amount of cancelled debt threatens to wipe out the tax advantages of the other two factors.
And of course our usual policy applies, where we will represent our clients in an audit and even in appeals, right up to the deadline that litigation may commence with only a reasonable co-pay. The $500 fee includes the following forms on the relevant tax return, where applicable:
1) Form 4797
2) Form 8582
3) Schedule D
4) Schedule E (as it applies to a particular rental property)
5) Form 982 (cancellation of debt)
The $500 fee includes the following analysis'
1) Cancellation of debt analysis
2) Capital gain analysis
3) Qualified Real Property Business Indebtedness (QRPBI) analysis
4) Insolvency analysis if required
The $500 fee does not include any analysis of either the client's position or the creditors position under state law as to the validity and enforceability of any debt. Our practice is strictly limited to income tax issues and we do not practice in any area of California law outside of the California income tax.