Homeowners who sell at a loss usually get no tax break, even as falling prices and higher borrowing costs push more sales into the red, tax experts warn.
Primary Residences Offer No Cushion On Losses
The IRS treats a primary residence as personal-use property, not an investment, so you generally can't deduct a loss when you sell your main home for less than you paid. By contrast, the tax code lets you exclude up to $250,000 of gains on a home sale and ($500,000 for married couples), but it offers no similar relief for losses, as the IRS emphasizes.
You move into a different territory when the property is strictly an investment or a rental. If you never lived in the home and used it only as a flip or long-term investment, IRS rules show that any loss generally counts as a capital loss that can offset other capital gains.
If losses exceed gains, you can deduct up to $3,000 a year against ordinary income and carry the rest forward indefinitely. Advisors at SmartAsset and Fidelity note that this is the same rule stock and fund investors use in tax-loss harvesting.
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Investment And Rental Properties Get Different Treatment
Rental property adds both opportunity and complexity. When you hold a rental for more than a year, a loss at sale often qualifies as a Section 1231 loss, which can offset wages and other ordinary income without the $3,000 cap.
But depreciation, which lowers your taxable income while you own the property, also lowers your cost basis and can turn what looks like an economic loss into a taxable gain, subject in part to depreciation recapture at rates up to 25%.
If you convert a former home to a rental, the IRS limits any deductible loss to the lower of your adjusted basis or the property's fair market value on the date of conversion. Vacation homes you use personally also remain personal-use property, so you generally cannot deduct a loss there either.
Documentation, State Rules Can Change Tax Outcomes
Tax professionals at leading U.S. tax firm, EisnerAmper, say documentation makes or breaks these claims. Closing statements, improvement receipts, depreciation schedules and appraisals all help you prove basis if the IRS asks and because states don't always follow federal rules on capital losses and passive activity, planners urge sellers with large real-estate losses to consult a local CPA before they sign on the dotted line.
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