The story is real but there are no names because everyone deserves privacy. A client was looking for help because she disposed of a home and didn’t know how to deal with the tax issues. This was simple. The facts were there, and not much I could do about it except crunch the numbers, which turbo tax does a great job of. Why on earth would she need a CPA?
The Problems: It turns out she divorced her husband three years earlier and they split their million dollar plus home (& mortgage) in the divorce, but they were going to hold onto it until the market turned around. Well, in the current year they sold the home at about a $750K loss. He had always done their return on turbo tax. So while they were waiting for the market to turn around, ex hubby decided to rent her half so when he came into town to visit their kids they would have a nice familiar place to stay. He paid her fair market rent/month but they called it additional child support so she wouldn’t have to report it on her taxes. To make it even more ridiculous, she and husband 2 (another smart guy who uses turbo tax) have another big home are now deep in excess of the $1MM mortgage limitation for homes 1&2. All of those excess deductions should be lost forever, only they are begging the IRS for an audit by claiming a deduction for all of around $125K of mortgage interest .
The Solution: As it turned out, the IRS had accepted their invitation to audit and denied all of the mortgage interest. We correctly amended the three and two year earlier tax returns to re-categorize the property as a rental the rental. This moved the activity from personal to business and recognized a passive loss which was deferred until the year of disposition. All losses became active upon disposition, wiped out current year taxable income and came to a net operating loss for the year and carried back to wipe out unpaid tax debt for the previous two years. We also proved the correct mortgage interest deduction. Fortunately the audit gave me single point person to funnel the corrections through and all of the adjustments are already on record as having been audited.
The Unsolvable Problem: The client spoke with her ex-husband and let him know that I was able to get her losses deducted and he was looking for the same help. I explained that had been helping him with his taxes 3 years ago when housing prices had plummeted, conversion to rental would have been an obvious tactic to take but since he was renting the ex-wife’s half for personal use, calling his half rental property would not fly. In short because of different treatment of the exact same piece of properly, one ex-had a business deduction of close to $450K and one had a nondeductible personal loss of about the same.
It would have cost him around $350 per year to get his tax return done and the advice that goes along with it. Yea for turbo tax!