Mistake Costs Taxpayer Ordinary Loss Deduction When He Sells | USTaxAid

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Mistake Costs Taxpayer Ordinary Loss Deduction When He Sells

Written by Diane Kennedy, CPA on July 24, 2022

One of the huge benefits to real estate investors comes when they sell their property. When they sell at a gain, they get to take advantage of the lower capital gains rate. And if they sell at a loss, they have an ordinary loss that can offset other income.

Contrast that loss treatment to what happens if you sell crypto or stock at a loss. It’s a capital loss, which means the ability to take a loss will be limited to just capital gains plus $3,000. Most people with big capital losses end up getting stuck having them carried forward for years.

The ability to deduct an ordinary loss is a very big deal for a taxpayer.

That’s why this taxpayer was so surprised when he found out that the IRS said he had a capital loss when he sold his real estate. He couldn’t deduct the loss against the income he earned as a lawyer. He appealed and lost. He took it to Tax Court and they had a surprising decision.

The Tax Court said it was a capital loss because he hadn’t started his business. He didn’t make any improvements to the parcels first. He didn’t make a living with real estate. He was an attorney.

This was just a side investment and that meant the loss was capital loss.

How could he have gotten a better result? 

Do something with the property first before he sold it. In other words, “start the business.” Even though this is real estate, you still need to show you’ve put it into some kind of service. Otherwise, you’ll pay a lot more in taxes.

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