Kenneth and Susan owned a rental condominium that they sold in March several years ago for $267,500. This sale closed in May. On April 6, Kenneth and Susan contracted to buy another investment property, but that purchase was canceled on September 10.
On Aug. 31 of the following year, Kenneth and Susan contracted to buy a vacant lot for investment, using proceeds from the condominium sale. Kenneth and Susan contend this qualifies as a Starker delayed tax-deferred exchange, authorized by Internal Revenue Code 1031(a)(3).
But the IRS denied the tax deferral, explaining Kenneth and Susan failed to designate within 45 days after the sale closed the property to be acquired with the proceeds. In addition, the IRS attorney emphasized, Kenneth and Susan didn’t complete the acquisition within 180 days from the date when they sold their rental condo.
If you were the tax court judge, would you rule Kenneth and Susan qualify for a Starker delayed tax-deferred exchange?
The judge said no.
“Among other requirements section 1031(a) provides that property received by the taxpayer shall be treated as property which is not like-kind, if it is not identified as exchange property within 45 days after the date on which the taxpayer transfers the original property in the exchange, or if the property is received more than 180 days after the original property is relinquished or, if earlier, after the due date of the taxpayer’s return,” the judge explained.
Because the lot acquired for investment was neither identified within 45 days after May 18 nor acquired within 180 days from that date, the judge emphasized, this transaction cannot qualify as a Starker delayed tax-deferred “like kind” exchange. In addition, a negligence penalty shall be imposed on the taxpayers, the judge ruled.
Based on the 1995 U.S. Tax Court decision in Kunkl vs. Commissioner, T.C. Memo 1995-162.
– In 1987, Ronald bought his personal residence for $124,000. He added capital improvements, which brought his adjusted cost basis up to $141,026. But in 1988, Ronald became unemployed. He listed his home for sale at $145,000 but the only offer received was for $130,000, which he rejected.
In June 1989, Ronald leased the house for six months. But in October 1989, he sold the house for $130,000 because he was still unemployed, behind two years on the property tax payments, and hadn’t paid the mortgage for three months.
On his 1989 income tax returns Ronald claimed a tax loss on the sale of his rental house. He said the house was worth $145,000 on the day of converting it to rental status. However, because his $141,026 basis was lower, he reasoned he had an $11,026 deductible sale loss.
The IRS, however, denied the loss deduction, explaining the house was worth only $130,000 when converted from personal use to rental status; so Ronald had no profit or loss since the house sold for $130,000 a few months later.
At that point, Ronald decided to take his dispute to the U.S. Tax Court, acting as his own attorney.
If you were the tax court judge, would you allow Ronald to deduct a loss on the sale of his rental house which was formerly his personal residence?
The Tax Court Judge said yes.
When a personal residence is converted to rental status, the judge explained, the lower of its fair market value on the day of conversion or the taxpayer’s adjusted cost basis becomes its rental property basis.
Although Ronald argued the house was worth $145,000 on the date of conversion to rental use, he offered no proof, such as an appraisal, to justify his opinion, the judge emphasized.
However, the IRS position that the house was worth only $130,000 when first rented didn’t consider all the reasons Ronald sold at that price, the judge continued.
Ronald’s unemployment, $4,551 unpaid property taxes, and threatened foreclosure surely influenced his decision to accept the low $130,000 offer, the judge noted.
The Tax Court Judge determined $135,000 was the house’s market value on the date of conversion to rental status, so Ronald has a $5,000 tax loss deduction.
Based on the 1995 U.S. Tax Court decision in Ronald Stanley Adams vs. Commissioner, T.C. Memo 1995-142.
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Please note: Real estate laws differ from place to place, and laws of your area should be checked before making decisions on real estate problems. Letters should be addressed to Tribune Real Estate Features Service, P.O. Box 280038, San Francisco, Calif. 94128.
