Here’s a question that I received over at USTaxAid.com regarding capital loss vs ordinary loss with real estate. In this case, the person writing is a real estate developer and real estate professional. That’s an important point.
I am a real estate developer and also sell real estate. On one investment set up as an LLC there was a loss selling the property. The property was a piece of commercial land with homes that were knocked down and we did manage to have the property rezoned. We owned the property for 10 years. The accountant for the LLC issued a K-1 to me (and the other members of the LLC). My K-1 was in the amount of ($500,000). In past real estate developments losses would off set other ordinary income rather than other capital gains. I want a strategy to use the $500,000 i lost to offset my ordinary income rather than capital loss at $3,000 per year. Can you suggest a strategy?
Let’s take a second and talk about definitions that the IRS uses.
Real Estate Developer
If you buy property to then develop or change it somehow before you put it in service or sell it, you are a real estate developer.
One of the tax challenges as a real estate developer is that you will have to capitalize both the direct expenses like development of the property and a portion of indirect expenses including G & A (general and administrative) expenses.
Real Estate Dealer
If you buy property to then sell it, you are a real estate dealer. That means you have a business, not an investment. The determination of real estate dealer is made on a property-by-property basis.
Normally, property sellers are looking for a way to avoid real estate dealer status. That’s because a gain would be subject to ordinary tax rates if you’re a real estate dealer. You don’t get capital gains.
In your case, though, you WANT to be considered a real estate dealer. That means you would have an ordinary loss, not a capital loss. The fact that it took 10 years to sell the property shouldn’t really matter. The last 10 years have been pretty brutal for a lot of real estate markets.
If you rented the property before it sold, you would have an ordinary loss. If you fixed it up to sell, you would have an ordinary loss.
The trick is to try to turn this into an ordinary loss. (And that might mean that you need to amend the original LLC partnership return.)
Otherwise, if you have a capital loss, the only thing you can do to offset it is to create a capital gain. You are limited to $3,000 above the capital gains per year. That means you’re look at over 150 years of tax write-offs unless you’re able to change something.
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