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Can an estate deduct a loss on the sale of the decedent's personal residence.

The technical unit of the Brookhaven Service Center of the IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws.  has processed several Form 1041s, U.S. Income Tax Return for Estates and Trusts, reporting losses from the sale of a decedent's personal residence and passing those losses along to the estate's beneficiaries on Schedule K-1. The Office of Chief Counsel has issued an IRS Service Center Advice Memorandum (SCA (Single Connector Attachment) An 80-pin plug and socket used to connect peripherals. With a SCSI drive, it rolls three cables (power, data channel and ID configuration) into one connector for fast installation and removal.  1998-012) in response to questions as to whether these losses are deductible That which may be taken away or subtracted. In taxation, an item that may be subtracted from gross income or adjusted gross income in determining taxable income (e.g., interest expenses, charitable contributions, certain taxes). , and, if so, whether they flow from the estate to the beneficiaries.

The memorandum states that, in general, an estate cannot deduct a loss on the sale of a decedent's personal residence. One reason is that an estate computes its taxable income Under the federal tax law, gross income reduced by adjustments and allowable deductions. It is the income against which tax rates are applied to compute an individual or entity's tax liability. The essence of taxable income is the accrual of some gain, profit, or benefit to a taxpayer.  in the same manner as an individual, and individuals may deduct only three types of losses: (1) losses incurred in a trade or business, (2) losses incurred in any transaction entered into for profit and (3) subject to certain limitations, losses from casualty or theft. The memorandum concluded that only the second provision is applicable to the sale of a decedent's personal residence (i.e., if the estate converts the residence to income-producing property). This situation is not unusual, especially when the administration of the estate is prolonged pro·long  
tr.v. pro·longed, pro·long·ing, pro·longs
1. To lengthen in duration; protract.

2. To lengthen in extent.
. The Chief Counsel, however, did not indicate that there could be any other situation in which a loss on the sale of a decedent's personal residence would be deductible. The memorandum states that an estate's income tax return reporting such losses should be examined to determine whether the estate converted the decedent's residence from personal property to rental property. The Service appears to be attributing a decedent's personal use of the residence to an estate; therefore, the estate's holding of the property for sale (at a profit), in the normal course of reducing the decedent's assets to cash, is not sufficient to constitute a "transaction entered into for profit." Would the IRS's position be different if an estate held the decedent's residence "for rent or for sale?"

Assuming that the estate converted the decedent's residence to rental property, and the loss is deductible, the memorandum states that if the estate is not the owner under state law, it cannot deduct the loss. When the decedent An individual who has died. The term literally means "one who is dying," but it is commonly used in the law to denote one who has died, particularly someone who has recently passed away.  owned the personal residence as a joint tenant with right of survivorship The power of the successor or successors of a deceased individual to acquire the property of that individual upon his or her death; a distinguishing feature of Joint Tenancy.  or as a tenant by the entirety, the survivor becomes the sole owner of the property. In this situation, the loss is reported by the surviving tenant, not by the estate. The memorandum also states that under New York New York, state, United States
New York, Middle Atlantic state of the United States. It is bordered by Vermont, Massachusetts, Connecticut, and the Atlantic Ocean (E), New Jersey and Pennsylvania (S), Lakes Erie and Ontario and the Canadian province of
 and New Jersey law (and the laws of many other states), title to real property passes directly from the decedent to the heirs and devisees.

This rule would appear to prevent an estate from deducting a loss even if title to the residence was in the decedent's sole name and the property was specifically devised. However, the memorandum states that, although estate representatives have no control over such property, they have the power to sell it if other assets other assets

Assets of relatively small value. For financial reporting purposes, firms frequently combine small assets into a single category rather than listing each item separately.
 passing under other types of dispositions have been exhausted. Accordingly, an estate should report on Form 1041 the percentage of loss recognized on the sale of such property equal to the percentage of the proceeds the estate uses to satisfy its obligations. The remainder of the loss is reportable directly by the heirs or devisees.

Example: D's will provided for a disposition of a personal residence to his child, C. Needing cash to pay estate expenses and having no other source of funds, the executor executor n. the person appointed to administer the estate of a person who has died leaving a will which nominates that person. Unless there is a valid objection, the judge will appoint the person named in the will to be executor.  sold the residence at a loss. Half of the proceeds from the sale were used for estate obligations and the balance was distributed to C. As a result, D's estate reported 50% of the recognized loss Recognized Loss

The amount of loss reported for income tax purposes.

You can defer recognizing some losses and then deduct the losses for the following year(s).
 and C reported the remaining 50%.

The memorandum does not indicate whether, in this example, the distribution to C would carry out distributable net income (DNI See Do Not Increase. ) (i.e., deductible by the estate under Sec. 661 and includible in the distributees' income under Sec. 662). The general rule is that bequests of specific property do not carry out DNI. It would appear that the distribution of the proceeds to C should not carry out DNI, because, had the property been divisible DIVISIBLE. The susceptibility of being divided.
     2. A contract cannot, in general, be divided in such a manner that an action may be brought, or a right accrue, on a part of it. 2 Penna. R. 454.
, C would have received the unsold portion.

Current New York and New Jersey law give estate representatives broad power and control over real property not specifically devised, even though, technically, title has passed directly to an heir or devisee devisee n. a person who receives a gift of real property by a will. The distinction between gifts of real property and personal property are actually blurred, so terms like beneficiary or legatee cover those receiving any gift by a will.

. Estate representatives usually deposit the proceeds from the sale of the decedent's real and personal property in one fund, used for the payment of estate obligations and distributions to the heirs and devisees. In this situation, the Chief Counsel conceded that, for practical purposes, the estate should report the entire loss from the sale of the decedent's personal residence. The memorandum, however, cautioned that "other factual situations may require a different result."

The memorandum also noted that, if the decedent's will requires the executor to sell the personal residence and distribute the proceeds to the beneficiaries, tide to the real property passes to the estate, not the devisees. In this situation, therefore, the estate reports the entire gain or loss on the sale of the real property.

Rev. Rul. 68-49 held that, because title to real property passes under local law directly from the decedent to the heirs or devisees, pursuant to Regs. Sec. 1.661(a)-2(e), a distribution of real property that comprised part of the residuary estate A residuary estate, in the law of wills, is any portion of the testator's estate that is not specifically devised to someone in the will, or any property that is part of such a specific devise that fails.  did not carry out DNI; this distribution was a nontaxable inheritance. The memorandum states that the principle of this ruling now applies only to specifically devised real property, The ruling is no longer applicable to nonspecifically devised real property, due to the amount of power and control estate representatives have over such property. A distribution of nonspecifically devised real property, therefore, will carry out DNI, despite the fact that, under local law, tide still passes directly to the beneficiaries.

The memorandum also indicated that the amount of the loss is the excess of the adjusted basis for determining loss over the amount realized “Amount Realized” is one of two variables in the formula used to compute gains and losses when determining gross income for tax purposes. The Amount Realized – Adjusted Basis tells the amount of Realized Gain (if positive) or Realized Loss (if negative).  from the sale. The basis for loss is the lower of the property's market value at the time of conversion or its adjusted basis at the time of conversion (which in most cases will be the date-of-death value, adjusted for alterations between the date of death and the date of conversion).

The memorandum also explained that losses generally do not flow from the estate to the beneficiaries. Capital gains are not included in the DNI computation to the extent that the gains are allocable al·lo·ca·ble  
Capable of being allocated.

Adj. 1. allocable - capable of being distributed
allocatable, apportionable

distributive - serving to distribute or allot or disperse
 to corpus and not paid, credited or required to be distributed to any beneficiary. Capital losses are also excluded from DNI, except to the extent such losses are taken into account in determining the amount of capital gains paid, credited or required to be distributed to a beneficiary. In the final year of an estate, the beneficiaries will succeed to any unused capital loss and net operating loss operating loss

The excess of operating expenses over revenue. As with operating income, operating losses exclude revenues and expenses from operations that are not considered a regular part of the business. Also called deficit. Compare operating income.

Estates reporting a loss on the sale of a decedent's personal residence, therefore, should expect an IRS audit. It may be prudent to advise estate representatives to hold the property "for sale or for rent" and retain adequate substantiation of attempts to rent the property. Alternatively, if the loss resulted only from selling expenses being added to basis, consideration should be given to deducting the expenses as administration expenses on the estate tax return or, if there is no estate tax, on the estate's income tax return.

Caution: The income tax deduction Tax deduction

An expense that a taxpayer is allowed to deduct from taxable income.

tax deduction

See deduction.
 may be claimed only if the estate fries a waiver of the right to claim the deduction on the estate tax return. In addition, the deduction may be of little or no benefit to the estate if the Service asserts that these types of administration expenses are deductible only to the extent they exceed 2% of adjusted gross income.
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Author:Aaronson, Marc A.
Publication:The Tax Adviser
Date:Aug 1, 1998
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