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!
Congratulations, you took advantage of the first time home buyer credit in 2008, 2009 or 2010 but now you have to move. Well it turns out there is a catch to the credit, (this is aside from the big question of whether or not tax dollars should be used to subsidize the construction industry under the guise of helping people buy homes). Generally, if you quit using that home as your main home within 36 months of purchase you are required to pay back the credit in full that year. (Home buyer credit) Interestingly enough, if you died you are deemed to having quit using that home as your primary residence and may have to repay the credit.
As they say, the devil is in the details, but in this case it could be salvation. There are some important broad exceptions to this. The most far reaching is if you sold your home to an unrelated party your repayment of the credit is limited to the gain on the sale of your home. This repayment limitation applies to all 3 years of the credit including 2008.
If you are unfortunate enough to lose money on the deal then you do not have to repay the credit beyond any amount already repaid. In most cases form 5405 needs to be filed recognizing the disposition with your tax return. If you look at the form sections IV & V will get a clear picture of how this works.
Like I said, the devil is in the details and specifics count in taxation. Form 5405 and the instructions are relatively concise and easy to understand on this issue. As always, consulting a CPA is a good ideal as well.