Rental Property CPA discusses Form 4797 | Rental Property Sale Resulting in a Loss for a LLC taxed as a Partnership

Rental property CPAs earn their keep when reporting the sale of residential rental property on IRS Form 4797. My example uses a LLC that elects to be taxed as a Partnership; filing Form 4797, Form 8825 and Form 1065. This post helps conceptualize the tax issues involved. Losses were unusual before the Recession, but I expect more short sales and foreclosures in 2013. Like any IRS issue, there are lots of details and you can’t reasonably rely on this post alone. Other sources of information include:

• IRS Pub. 946, How To Depreciate Property.
• Instructions for Form 4797.

Designed for multiple purposes, the terminology and format on Form 4797 can intimidate clients. Where do you enter the figures on Form 4797? Exact placement on Form 4797 depends on;

• Whether there is a capital gain.
• Whether there’s a capital loss.
• How long you, or your company, held the rental property.

“Even a rental property CPA finches at the complex IRS descriptor on Form 4797, Sales of Business Property (Also Involuntary Conversions and Recapture Amounts Under Sections 179 and 280F(b)(2)).”
- Gary Bode, rental property CPA

Simplistic Example of Capital Loss Calculation

Flow of the LLC Partnership Tax Return

Form 1065

For this example, the business entity is Rental Property CPA LLC, being taxed as a Partnership on Form 1065.

• The profit or loss from rental activities goes through Form 8825.
• Each Member’s portion of rental activity profit and loss flows from Form 8825 to Line 2 of Schedule K-1 of Form 1065.
• The sale gets reported on Form 4797, part 1.
• In this case, the rental property was held longer than one year and resulted in a loss. The Member’s losses flow from Form 4797 to Line 10 of Schedule K-1 of Form 1065.

Member’s Form 1040

• Rental profit and loss from Schedule K-1 flows to Schedule E and then into the Income section of Form 1040.
• Loss from the sale flows from the Member’s K-1 to Line 14 of Form 1040 (other Gains and Losses).

Depreciation Primer

Land can’t be depreciated. So the cost of the land is segregated from the cost of the building and improvements. The cost of the building gets incrementally deducted on your annual Form 8825, through straight line depreciation over 27.5 years.

Example

• On January 1st, 2009, Rental Property CPA LLC purchased a residential rental property duplex for $320,500.
• Rental Property CPA LLC sold the duplex on December 31st, 2013 for $270,000. CPA’s closing costs on the rental property sale were $5,000. Land value did not change.

Purchase

• Cost of land; $60,000. It’s best to have some justification for the land’s value e.g. tax listing, appraisal etc.
• So $260,500 was for the building. ($320,500-$60,000).
• Rental Property CPA LLC immediately put in $10,000 of improvements to the building.

Depreciation

• On the annual Form 8825, CPA LLC deducted $10,000 depreciation on the building and improvements for 2011, 2012 and 2013. {($260,500 + $10,000) / 27.5 years }. Note that depreciation for the building still appears on the 2013 Form 8825 even though 2013 was the year of sale.
• So total Accumulated Depreciation during the ownership of the rental property is $30,000. $10,000/year x 3 years = $30,000

Loss Calculation

• Sales Price of Land and Building = $270,000
• Original Cost = $320,500 purchase price + $10,000 Improvements = $330,500.
• Add Back Depreciation = $10,000 x 3 years = $30,000 Accumulated Depreciation.
• Less Sales Cost = $5,000
• Loss = $270,000 Sales Price - $330,500 Purchase Price + 30,000 Accumulated Depreciation - 5,000 Sales Expense = ($35,500).

Rental Profit and Loss on Form 8825

Rental Property CPA LLC still filed Form 8825 for 2013. Note the 2013 Depreciation appeared on Form 8825 and then got added back in the sale’s loss calculation.

Tax Implications

The technical term is Section 1231 loss. All Members of Rental Property CPA LLC were active in the property’s management. So the loss can offset ordinary income. If the loss reduces the Member’s personal taxes below zero, the unused part can be carried back two years by amending those returns via Form 1040-X. If there is still unused loss, it can be carried forward 20 years. This post doesn’t cover passive losses, but be sure to ask your rental property CPA about them.

This post covers the basics, but some situations require additional IRS forms:

• Use Form 4684, Casualties and Thefts, to report involuntary conversions from casualties and thefts. Like Superstorm Sandy.
• Use Form 6252, Installment Sale Income, to report the sale of property under the installment method.
• Use Form 8824, Like-Kind Exchanges if you’ve exchanged assets.

We’re a rental property CPA firm with a virtual office. If you like what you read, don’t let distance dissuade you. For a free initial phone consult, please call (910) 399-2705.

My experience includes being the controller for a luxury residential construction firm with 30+ rental property LLCs. During college I was the residential manager of a 52 unit residential apartment complex. My extended family owns rental property. So I stay current on landlord tax issues. And of course I prepare Form 8825, Form 4797, Form 1065 and Form 1120-S on a regular basis.

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