In the current housing market, being a seller can be a tough proposition. As my husband finishes his Ph.D., and we start to consider what might happen in the next 12 months, it is becoming apparent that the housing market may not recover by the time we are in a position where selling our home becomes necessary. If that comes to pass we would probably sell the house at a loss.
Selling at a Loss
No one likes to think about selling their home at a loss, but it has become a harsh reality for many. Many people have had to sell for less than they paid for the home. This constitutes a real estate capital loss. However, you do not get a tax break when you sell your home at a loss. If you take a look at IRS Publication 523 it becomes painfully obvious that you aren’t going to be able to get a tax deduction when you sell your primary — or even your secondary — home for less than you bought it for.
Unfortunately, capital gains and losses with real estate aren’t the same as those you see with other investments like stocks and bonds. You cannot use capital losses from your primary real estate to offset capital gains elsewhere. This is likely due to the fact that when you sell your home for a gain there is a generous capital gains exclusion that allows you to avoid paying taxes on some (or even all) of your capital gains from the sale (up to $250,000).
Additionally, if you sell your home at a price that is less than the remaining balance on your mortgage, known as a short sale, you may have to pay more in taxes. If the mortgage lender forgives you the difference between what you owe and what is paid for your home, that difference is actually taxed as income.
Investment Property and Losses
While you won’t be able to deduct losses from the sale of your primary or secondary home, you can get a tax deduction for losses associated with investment property. If you sell a rental property or other investment property at a loss, you might be able to deduct it from your income. Investment property is treated a lot like equity investments. However, you need to make sure that the property meets the IRS definition of an investment property before you start deducting losses.
Looking for more tax breaks? Costs associated with owning and maintaining a rental property can be deducted against your rental income. However, there are strict rules about how this works, and you will need to be careful to make sure that you follow the IRS rules and definitions for what is deductible.
If you have to sell your primary residence for less than you bought it for, you are out of luck when it comes to tax deductions. You need to be careful if you must go through a short sale or some other form of mortgage loan forgiveness from a lender since you might end up owing more in taxes.
Miranda is a professional personal finance journalist. She is a contributor for several personal finance web sites. Her work has been mentioned in and linked to from, USA Today, The Huffington Post, The San Francisco Chronicle, The New York Times, The Wall Street Journal, and other publications. She also has her own blog at Miranda Marquit.