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

Your CPA earns their keep when reporting the sale of rental property on IRS Form 4797. This post helps conceptualize the issues behind the taxation of losing money on a sale of residential rental estate property. This was unusual before 2009, but, as any rental property CPA will tell you, it is now the norm. 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.

“Even a rental property CPA flinches 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 and tax accountant

Designed for multiple purposes, the terminology and format on Form 4797 can intimidate clients. Where do you enter the figures? Exact placement on Form 4797 depends on whether there is a capital gain or loss, and how long you, or your company, held the rental property.

Simplistic Example of Capital Loss Calculation

Flow of the LLC Partnership Tax Return

Form 1065

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

• The profit or loss from rental activities goes on Form 8825.
• Each Member’s portion of rental activity profit and loss flows from Form 8825 to Line 2 of Schedule K-1.
• 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, so the Member’s losses flow from Form 4797 to Line 10 of Schedule K-1.

Member’s Form 1040

• Rental profit and loss on 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 is gradually deducted on your annual tax form, Schedule E or Form 8825, through depreciation over 27.5 years. IRS depreciation has a multitude of complications. We’re using straight line depreciation as the simplest example.

Example

On January 1st, 2008, CPA LLC purchased a residential rental property duplex for $310,500, of which $260,500 was for the building. $60,000 was attributed to the cost of land. CPA LLC immediately put in $10,000 of improvements to the building. On the annual Form 8825, CPA LLC deducted $10,000 depreciation on the building and improvements for 2008, 2009 and 2010 {($260,500 + $10,000) / 27.5 years = $10,000/year}. CPA LLC sold the rental property on December 31st, 2010 for $270,000. CPA’s closing costs on the rental property sale were $5,000. Land value did not change.

Loss Calculation

• Sales Price = 270,000 - 60,000 = 190,000.
• Less Original Cost = 260,500 + 10,000 = 270,500.
• Add Back Depreciation = 10,000 x 3 = 30,000.
• Less Sales Cost = 5,000
• Loss = 190,000 - 270,500 + 30,000 - 5,000 = 55,500.

Tax Implications

The technical term is Section 1231 loss. All Members of CPA LLC were active. So the loss can offset ordinary income. If the loss reduces the Member’s personal taxes below zero, the unused portion 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. On a rental property gain, the CPA would treat the depreciation differently than the remainder of the gain. 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.
• 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 in Wilmington NC, but serve a broader base through our virtual office. For a free initial phone consult, please call (910) 399-2705.