1031 Exchange
I sold a rental property in March of 2001 with adjusted basis of $175k, then 1031'ed into another rental property in May of 2001. All taxes were deferred when I filed my 2001 1040 in 2002. I also had $50k of deferred passive activity loss at that point in time.
My tenants moved out 7 months later on 12/31/2001 and I couldn't rent the property out for a long time after 2002 began. At the same time my own home needed major repair work so the rental property became our primary residence for over 3 months.
By mid-March my father was diagnosed with cancer. He passed away in May. To properly care for my mother who lived far away we decided to sell the property and "be done with it". The property was sold in July, 2002.
Now the 2002 1040 is due I have the following questions:
I guess I converted the rental property to primary residence after my tenants moved out. If this is true then how can I let the IRS know this is what I did beginning on 1/1/2002?
I learned 3 months ago that if I sell my primary residence because of death in the family my gain (over the adjusted basis) is tax free ($500,000 if married filing jointly multiplied by the number of days of residency). Does this apply in my case?
If I did convert my rental property to personal use then I should be able to apply my deferred passive activity loss against all of my 2002 income. Am I correct? How is this done now I don't have a Schedule E to file?
Frederic,
You have what seems to be a complicated set of circumstances to sort through. I suggest you consult a tax professional for specific guidance in completing your tax return.
Your first question is whether the rental property became your primary residence. In my lay opinion it did not. Your primary residence remained your primary residence while repairs were underway. You occupied your rental property as temporary quarters until the repairs were completed on your house and then moved back into your repaired home (your primary residence). So, in my opinion, you are not eligible for the capital gains exclusion on the sale of a primary residence in this case.
What you have is the sale of an investment property with a brief period of personal use. This is called a hybrid use property. When you do your tax returns, the costs of operation and ownership allocated to the portion of the year that the property was held out as a rental can be deducted on your Schedule E. You may not take normal operating expense deductions for the portion of the year that you occupied the property for your personal use. You may deduct property taxes and mortgage interest -- ownership expenses -- prorated for your period of personal use. Take these deductions on Schedule A.
Your last question dealt with suspended passive losses. It is my understanding that suspended passive losses from the relinquished property in your 1031 exchange are applied to your adjusted basis for the replacement property and are not carried forward as prior year suspended losses for the replacement property; they are "consumed" by the exchange. When you sold the replacement property in 2002, any suspended losses you accrued since your 1031 exchange will again be applied to your adjusted basis before your taxable capital gain is calculated.
Again, this is my layman's opinion. I strongly suggest that you enlist the services of a tax professional to help you wade through all these issues.
Thank you DaveT. You are right about of the complexity. I am now seeking professional help.