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Forfeit of deposit on rental property

Level 3

Hi --

My client is putting down $200,000 in earnest money on a large commercial rental property. If he loses that money, how do I report it?

I think it would be a capital loss, but a capital loss from a passive real estate investment would normally be suspended until the building is sold. In this case, the building is not being sold--since he never actually acquired it.  

How to report this?  And will he get to use the $200,000 loss against ordinary income in the current year?

Thank you!

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21 Replies 21
Level 15

How and why?

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Still an AllStar
Level 3

Didn't I explain the situation?  What additional information are you looking for?

Thank you.

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Level 15

You only said he lost it and explained what you think the tax treatment is but you didn't give any context as to why or on what terms your client lost the deposit, which may affect the answer to your question.

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Still an AllStar
Level 3

The transaction has not happened yet. We are considering what the tax treatment would be IF he put down $200,000 and then did not actually acquire the building and forfeited his deposit.

Thank you.

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Level 13

But WHAT would be the reason for not acquiring the property?

Did he find something he liked better?  Did the seller back out?  Did the building burn down?  Did everybody die of COVID?   The "why" often matters.

Level 3

Let's say the seller backed out.

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Level 8
Level 8

Not sure i want to touch this because there are too many variables with real estate contracts... but i don’t see a loss against ordinary income. Since the transaction never concludes and the asset isn’t put in service, the most i can see is a sch D loss. 

Level 8
Level 8

@TaxGuyBill I was thinking the buyer signs an as is contract and discovers property flaws, liens, or other deficiencies and walks away. At best it’s just a bad investment.

Level 3

If you know the tax treatment for that scenario, I'd love to hear it.

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Level 3

Thanks, Skylane. That's pretty much what I was assuming also. That it would be a capital loss.

But then what?  It probably becomes a suspended loss, because it's passive. But then you get to take suspended losses when you sell the property. In this case, there isn't really a sale, of course, since there was no purchase.

I saw instructions in TaxSlayer blog that said to enter it as if you bought the building for $200K and then "sold" it for $0. That way the property is disposed of, for tax purposes, and you can recognize the loss. 

I wouldn't know how to enter that into Intuit ProSeries Basic, though.

And of course I'd like some corroboration that this is a legitimate treatment also. 

 

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Level 8
Level 8

Don’t think I care for the taxslayer approach. Hard to dispose of something you don’t own. I don’t see it rising to the level of a passive activity.   
@itonewbie @TaxGuyBill ...I’m on somewhat shaky ground; what say you?

Level 3

Hi Skylane,

I understand your hesitation about that approach.

And yet--it IS money lost in the course of doing business. It seems it ought to be tax deductible in SOME way, right?

Thank you.

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Level 15

@hcliston  We are still very short on facts.  What we have from you thus far is a lot of assumptions.  You need to gather the relevant facts because these will determine the proper tax treatment.  Fitting facts around certain tax treatment is not the solution.

Generally, you can't take a deduction/loss for money you have a reasonable prospect of recovering.  For a sizable commercial contract, it would be highly unusual your client doesn't have a competent attorney reviewing the terms to ensure there are legal provisions to protect his/her interest in case of contingency, especially if it's the seller's fault or there are significant defects in the structure (perhaps other than what has been priced in).  If we presume that the seller defaults on the contract and your client is not able to recover the money after pursuing all the appropriate avenues, your client may end up having a business bad debt - but that is a big IF and we just don't have the facts.

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Still an AllStar
Level 11
Level 11

Just my two cents, but I think we are overthinking the issue. generally if you put money down for escrow as good faith money for a rental building, and you lose it (changed mind, you could not get financing, ETC.) it is a capital loss. 

Level 15

I would digress with @Terry53029.  Without knowing the terms and facts surrounding the "loss" of the earnest money, it would be presumptive to say that it should be taken and allowable as a capital loss.

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Still an AllStar
Level 11
Level 11

Yes @itonewbie I agree with you that we don't have all the facts, and we rarely get them. That's why I've said in the past its hard to answer a question about taxes, because of so many variables 

Level 3

Thanks, Terry.  Can you tell  me the steps to enter that correctly in ProSeries Basic?

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Level 7

Why in the first place would you put 200,000 dollars in earnest money down to purchase real estate and it not be refundable if the transaction not go through??

Level 3

If it helps you think about it, imagine that the deposit is $1,000. My question is the same--capital loss or ordinary loss? And how to enter it in ProSeries Basic.

Thank you!

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Level 15

@hcliston  We have explained in different ways you did not provide us with sufficient facts and context.  If you are not able to or willing to share with us more information, I'm not sure anyone here will be able to give you anymore suggestions.

If you are no longer interested in a technical discussion but are simply looking for guidance on input, that would be a different story.

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Still an AllStar
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Level 11
Level 11

@hcliston  As I said earlier, generally it would be a capital loss, and is put on schedule D. This year 2020 ProSeries Pro has added a schedule D worksheet, Not sure about basic, but it goes on schedule D as a short term loss, but only from my understanding of the facts which could be wrong.