View Full Version : Claiming a loss from the sale of inherited property

Mar 13, 2009, 01:01 PM
I have talked to at least a dozen different people, including four people at the IRS and two CPA's, and I can't seem to get an unequivocal answer to my question. I inherited my mother's house in late 2007 and sold it at a loss four and a half months later. I have a qualified appraisal to establish the cost basis. Can I deduct the loss on my tax return? The house was empty from the time my mother died until it was sold. No one lived in the house, and I never intended for anyone to live in it or to have any other personal use of the property. I started preparing the house for sale about two weeks after my mother died and then listed it for sale. I have been given three different answers from the IRS: (1) the property was personal use property because it retained its character as such after my mother died (one person at the IRS claims this has been established in the courts) and thus the loss is not deductible; (2) the property was investment property because it was neither personal use property nor business/rental property and there was nothing left for it to be except investment property, amd thus the loss is deductible; or (3) the property had a neutral characterization because it didn't fit into any of the other characterization, and thus the loss is deductible. Two CPA's that I have spoken with say that the loss is deductible because the property was investment property, but there are other CPA's online who have the opposite opinion. One person at the IRS said that in order for it to be considered investment property, I would have had to hold it as such for five years. I don't want to get into trouble with the IRS -- does anyone have a definitive answer to this question -- something that I can absolutely rely on in case of an audit?

Mar 14, 2009, 03:06 AM
My opinion:
You did not inherit investment property. You inherited house property. So loss is not deductible.

Mar 14, 2009, 05:02 AM
Below is what IRS Pub 559 says:

Sale of decedent's residence. If the estate is the legal owner of a decedent's residence and the personal representative sells it in the course of administration, the tax treatment of gain or loss depends on how the estate holds or uses the former residence. For example, if, as the personal representative, you intend to realize the value of the house through sale, the residence is a capital asset held for investment and gain or loss is capital gain or loss (which may be deductible). This is the case even though it was the decedent's personal residence and even if you did not rent it out. If, however, the house is not held for business or investment use (for example, if you intend to permit a beneficiary to live in the residence rent-free and then distribute it to the beneficiary to live in), and you later decide to sell the residence without first converting it to business or investment use, any gain is capital gain, but a loss is not deductible.

Even though the Estate may be settled, I don't see why this would not apply to your situation.

Mar 14, 2009, 06:00 AM
I haven't done independent research, but the quote from Pub. 559 by MLSNC sounds like it should answer your question, and that the loss should be deductible because the house was empty.

Mar 14, 2009, 06:58 AM
Frankly I don't think Pub 559 applies here UNLESS the house was sold by the estate. If that was the case, then the loss would be deductible against estate taxes, not your personal income taxes.

If the property was transferred to your name, the appraised value at the time of transfer would become YOUR cost basis. If the house sold for less than that a loss would occur.

Since you are getting conflicting rulings on whether that loss is deductible or not, I would deduct it. IF you are audited, show them the research you had that supports deducting. At worst they will simply require you to pay the taxes you would have paid.

Mar 14, 2009, 11:21 AM
Thanks to everyone who responded to my question. As you can see, I still am not getting a definitive answer to this question! It doesnn't appear that there is a clear answer. Has anyone hard of the "new case law" that the IRS agent referred to when I spoke with him on the phone on 3/13/09? (See my original question.)

Mar 14, 2009, 06:03 PM
In Estate of Miller v. Com'r, 26 TCM 229 (1967), the facts were very similar to your case and the loss was allowed as an investment loss.

Mar 14, 2009, 07:40 PM
That's a great help! Thanks so much. I'll go to the law library and get a copy of the case. Thanks again!

Mar 14, 2009, 07:47 PM
I just noticed that the date on the cite is 1969. Do you know if the case has been overturned? The IRS agent referred to "recent" case law when he said that property retains its character after title passes to the beneficiaries. I hope he's wrong!

Five Rings
Mar 15, 2009, 02:31 PM
With so much expert opinion on hand I hesitate to even express mine, nevertheless...

The ownership of the house has nothing to do with the Estate. By bequest, the property is in the hands of the beneficiary. It is her personal property now.
Turning our attention to Pub. 544 we see that ordinary gain or loss is determined by whether an asset is either a capital or non-capital asset. A capital asset is very closely defined and a non-capital asset is defined as anything that is not a capital asset. Listed in number 3 of non-capital assets is rental property.

But, this property was never offered for rent. From the initial description, it was merely prepared for sale and then sold; there was no element of personal use by the beneficiary. Neither was there any contemplation of using it as a rental property.

Unquestionably, this house is a capital asset since, by definition, it is an investment property. It belongs to the beneficiary, it can be held for as long as is suitable, it can be used in any manner she deems fit, and can be sold when and if she chooses. It is no different than stocks or bonds.

Thus, since investment property is a capital asset, gain or loss from the sale or exchange of that property is a capital gain or loss.

As to "retaining its character", what is its character? It is an unoccupied house that the beneficiary is neither living in or renting. What would be the difference if the house had been acquired at auction and then sold at a loss from the auction price purchase?

Take the loss.

Mar 15, 2009, 03:57 PM
Thanks to Five Rings for the response. The "retained character" that the IRS agent referred to is the character of the house when my mother owned it, before she died. His adamant position is that since it was personal-use property when she owned it, it retains its personal-use property after title passes to the beneficiary (me). He said that there is recent case law establishing this. Until he mentioned "recent case law," I was very comfortable with claiming the loss, because the majority of what I have been able to find in my research, including here, supports that position. But if there is indeed recent case law in which the tax court decided that inherited property retains the character that it had in the hands of the decedent after title passes to the beneficiary, then I'm not comfortable claiming the loss until I know if the IRS agent was right or not. This is what I'm having trouble getting clear about. Does anyone out there know anything about this recent case law? If it does exist, does it apply to inherited property sold in 2008? I have been unable to find anything about it online. The Miller cite mentioned earlier is from 1969, which is not recent case law.

Five Rings
Mar 16, 2009, 04:24 AM
If you want to be 1000% sure of the position the IRS will take you can request a private letter ruling.
Before going through that time consuming and somewhat costly hassle you might want to search Legalbitsteam since the agent says it is a recent case:
www.legalbitstream.com (http://www.legalbitstream.com/case_law.asp?pl=c1)

I still am somewhat bewildered by the argument that an asset you are not personally using is a personal use asset.

Mar 16, 2009, 05:38 AM
His adamant position is that since it was personal-use property when she owned it, it retains its personal-use property after title passes to the beneficiary (me). He said that there is recent case law establishing this.

So go back to him and ask him for a cite. Or you can take the private letter ruling route that Five Rings suggested.

Personally, I would just take my chances and claim the loss and see if the IRS disallows it.

Mar 16, 2009, 12:01 PM
Thanks again to Five Rings and Scott Gem. I'm going to claim the loss and see what happens. It makes me nervous, though, because if you talk to four people at the IRS, two of them will say it's deductible and two of them will say it's not. So I guess it just depends on who at the IRS looks at my tax return. If anyone else reads this question and has a definitive answer, especially about the "recent case law," please let me know. If I find out anything elsewhere, I'll post it here. I'll also check out the website that Five Rings mentioned.

Mar 16, 2009, 12:05 PM
If you can document that you were told it was deductible, even if the IRS rules against you, then they just will require you pay the extra tax due. But unless your return is unusual, it may never be looked at.

Mar 16, 2009, 12:08 PM
I have printed everything I found online that supports my position, including IRS Pub. 559, p. 16, "Sale of Decedent's Residence." I know there won't be a penalty, but I assume there would still be interest if the loss is disallowed in an audit.

Mar 16, 2009, 12:24 PM
I have printed everything I found online that supports my position, including IRS Pub. 559, p. 16, "Sale of Decedent's Residence." I know there won't be a penalty, but I assume there would still be interest if the loss is disallowed in an audit.

Not necessarily. Interest and penalties are used when someone deliberately tries to cheat. I don't think they would be applied in your case.

Five Rings
Mar 16, 2009, 01:15 PM
I have gone to Legalbitstream and researched "all court cases" under the search term "inherited property".

With 19 cases found and going back to 1990 there is nothing in case law that seems to support the IRS agent's contention regarding " retained character"

Mar 16, 2009, 01:24 PM
Thanks so much for taking the time to do that research. I also looked and didn't find anything. I have a friend who is both an attorney and a CPA. He said that the next time he's at the law library, he will research this issue for me. I'll let all of you know what he finds out, but I don't know when it will be. It's truly amazing the kinds of answers a person gets from the IRS. Imagine this! One agent told me that if I even set foot inside the house after my mother died, it would constitute personal use. I asked her if she thought that if I had investment property that I had held for several years and I wanted to sell it, I could not go inside it to clean, make repairs, and show it to realtors without changing the character of the property to personal use, she said that was right! I asked if she thought that if had a rental property and went inside to fix a leak for the tenant, the property would change from a rental property to personal use property, she wouldn't respond. These are the people our taxes are paying for!

Five Rings
Mar 16, 2009, 04:11 PM
That is why we have the courts, thank God.