Taxpayer converted their rental, with passive loss carryovers, to a primary residence. I'm trying to determine as to whether these losses can be used on the eventual sale of the property (now their primary residence) or whether the PALs must be carried forward and only can be used against current or future passive income. The sale of the house will also qualify for the $500,000 section 121 exclusion.
I've read several authoritative articles and they seem to be giving contradictory advise. All of the advise is referring to IRS Memorandum 201428008. I've read the memo and it seems to me that the PALs will be freed up upon sale and thus deductible. Any thoughts?
The conclusion statement for Memo 201428008 states:
"Gain excluded from gross income under Section 121 of the code in not an item of passive activity gross income for purposes of section 469. Therefore, the excluded gain does not offset suspended passive activity losses. To the extent that the losses from the rental activity, including the suspended passive activity losses, exceed any net income of gain for the taxable year of the disposition from all other passive activities, the losses will be treated as NOT FROM A PASSIVE ACTIVITY."
It seems to me that if the losses will be treated as "not from a passive activity' then they will be freed up and be able to be used against ordinary income.
Appreciate any thoughts?
Yes, the losses are freed up on sale of the property (and will offset other non-passive income and/or possibly create an NOL if the stars are so aligned.)
For a while it was debatable whether a sale with Section 121 exclusion constituted a "fully taxable transaction" but, as you found, the IRS determined that "taxable then excluded" counts.
Taxpayer converted their rental ... to a primary residence.
The sale of the house will also qualify for the $500,000 section 121 exclusion.
As a side topic, you know that the taxpayer has "Nonqualified Use", right? So the exclusion won't cover all of the gain.