HOW TO AVOID A NON-DEDUCTIBLE LOSS ON THE SALE OF YOUR PRIMARY RESIDENCE

You want to sell your principal residence, but the housing market has deteriorated. Nobody wants to buy your property at the price you are asking. If you lower the asking price substantially, you’ll be able to sell your home, but you will also incur a loss. For example, let’s say you purchased your home for $300,000 and you’ll only net (after real estate commissions, closing costs, etc.) $250,000 resulting in a loss of $50,000.
 
What can you do with this loss? Because the loss is on your principal residence, there is nothing you can do with it. You cannot deduct it for tax purposes.
 
Now let’s say you decide to rent the house rather than sell it. The house is no longer categorized as a residence but as a rental property. This opens the door to a whole laundry-list of expenses deductible for tax purposes. For example, you can deduct utilities, the cost of the gardener, the repair of the dishwasher. Almost every outlay of cash on repairs and maintenance of the rental property is deductible for tax purposes including property taxes.
 
And then there is that wonderful non-cash deduction—depreciation. Let’s say your property is rented furnished and that furniture and fixtures are worth $30,000. For tax purposes you can take depreciation expense on both the furniture and the rental property. 
 
How much can you take? The house can be depreciated over a 27.5-year life. So for each year, you can deduct approximately $10,909 ($300,000/27.5) as an expense on your tax return. The furniture has a shorter life—5 years. Annual depreciation expense on the furniture is therefore $6,000 ($30,000/5). In this example, depreciation just gave you an additional expense of $16,909 ($10,909+$6,000) that you can use to lower your taxes, even though you didn’t spend a cent on the purchase of your home and furnishings in the current tax year.
 
What happens if you already have a loss for tax purposes without including your depreciation expense? No problem. Any unapplied loss can be “carried forward” and used to lower future taxable income.
 
As an added bonus if you elect to sell your rental property and the real estate market is still in the doldrums, you are able to take any loss on sale as a deduction for tax purposes. On the other hand, if you have held the property for more than a year and you make a profit on the sale, your gain is not taxed at your tax rate but at the more taxpayer friendly long-term capital gains rate.
 
This is one way in which real estate investors and developers are able to accumulate loss carry-forwards that allow them to pay no income tax for many years—or at most $750.