Convert to Rental for 3 months before selling house

Hi all,



I am working on a return with a couple things I want to make sure I have correct.



Client had a main home and moved out in December 2021 with hopes to convert to a rental property.  They had it on the market for 3 months after doing some repairs and fix-up kind of things.....but they could not rent it out so they decided to sell it 3 months later.  1) They still qualify for the full Sect. 121 exclusion because of the rental occurring after living it in for 2+ years, 2) they sold it in April 2022 at a nice gain.  They want to deduct the expenses for those 3 months of being on the rental market (approx. 7800 dollars), so I set up a schedule E showing zero income and the expenses.  Then I have the sale showing on form 4797 for the sale of this rental and on there it has the Sect. 121 exclusion.  No depreciation or recapture or anything because it was a rental for less than a year.  Does all that sound correct?



Thank you for your advice and info.!

I would question whether the home was actually converted to rental use. Sounds like the repairs and fix-up expenses were to prepare the home for sale.

Yeah, I agree and repeatedly brought it up to him and told him the risk of audit but he wanted to proceed anyways and said it was all legit. Let's say it is....is how I handled it with the forms correct (the 4797 sale of business property + the sect. 121 exclusion)?

Was it publicly listed as available for rent?

Was it in habitable condition?

Were they required to obtain any rental permits? If yes, did they obtain them?

Can they treat it as a second home and benefit from the three months of interest and property taxes?

Do any of the "repairs and fix-up kind of things" qualify as an improvement?

Don't let the client run the show. Ask relevant questions and convey what the options are and the pros and cons of each.

It was publicly listed and in habitable condition. No permits required. Could benefit from the mortgage interest ($4600) but that's about it, the other 3k in expenses would be lost if we took the schedule E away. Repairs were about 1800 and minor things, not improvements,

ajt1970, not sure what you mean when you say "They had it on the market for 3 months." The rental market? The sales market? Both? If it was truly available for rental for 3 months, I still would not consider this a bona fide rental. Most likely, the home was available "for sale or rent." Abandoning a home used as a personal residence and making it available “for sale or rent” does not convert it to income-producing purposes. See Rogers, T.C. Memo. 1965-8; Sweet v. U.S. (N.D. Calif. 1968).

As ManVsTax says, don't let the client run the show. Not only is the client on the hook for taking the position that the expenses are rental expenses, but so are you.

NoCalCPA85, Yeah, I hear what you're saying. He is a realtor and he says he truly wanted to rent it out and so he listed it on whatever realtor-access site he uses but then when he couldn't get the rent amount he wanted he says he decided to sell it. But the original intent, according to him, was to rent it out.

I think you have exposure from the angle of the client not making a bona fide effort to get a tenant in place.

I'd want to know the facts. All of them, but specifically why the client changed his mind. Did he get any interest? Did he entertain that interest? If he didn't, did he lower the rent rate? If not, why not?

This is one of the times you really have to grill the client. In a non-accusatory manner of course. Just make him aware that this situation is unusual and you need to ask questions until you're comfortable that you understand what happened.

he couldn't get the rent amount he wanted

Was that amount realistic/FMV?

Hey says it was realistic and FMV and that he even came down quite a bit in price. He said he showed it to many potential renters.

But lets say it is all legitimate, it was intended to be a rental, then a schedule E and form 4797 is the way to go? No depreciation as it was a rental for less than a year.

Yes.

I find it really hard to believe a realtor wasn't able to find out accurate rent comps for the property before they decide to rent it out, and at least do a back-of-the-napkin to determine if the would be cash flow positive at that rate.

Something doesn't add up for me. The fact that it wasn't purchased as a rental, but rather was a residence for the entire time, except for the three months before sale, means that the client has a higher threshold of presumption to jump over. At least that's my opinion.

Hey says it was realistic and FMV and that he even came down quite a bit in price. He said he showed it to many potential renters.

If he had to come down quite a bit in price then it wasn't realistic. More inconsistency.

How long did he stay at the lower rate before listing it for sale? Hours, days, weeks, a month?

How does the lower rate actually compare to rent comps?

I believe him when he says he truly wanted to rent it out. He's a credible guy. The amount of expenses are only 7800, which equates to maybe an 1800 tax benefit, peanuts to this guy. I think he much rather would have wanted to rent it out and collect the rents each month, but I think it got to the point where he couldn't get the price he wanted and realized it was too much hassle to be concerned about so he just decided to sell it, simple as that. My original question was not whether he should take the deductions or not, it was if I got the right forms on the return since it involved a conversion and then a sale of an asset held less than a year, plus the section 121 exclusion.

ManVsTax, he said he did do comps. He said he wanted to rent it for, I believe, 3300 or so and then came down to as low as 2700 per month but got no takers except those who wanted to go month-to-month and not sign a lease, so that is when he decided to sell it.

He is a part time realtor but earns well into 6 figures with his main day job, so I don't think it's all that big a deal the 1800 benefit he would receive by it. My concern is to just get the tax forms right.

It really doesn't pass the smell test. $3,300 down to $2,700?
Is this house in a bad neighborhood? Is that why he moved out? What's wrong with the house?
Last year by all accounts, the real estate market - rental and sales- was booming.

https://www.rentometer.com/

Run the rent comps yourself.

If they weren't fair market rate and he used the property as a residence for more than 14 days during the year, this all falls apart under 280A as the 3 months are not a qualified rental period.

I know he bought a new house December 2021 and moved right in so I know he didn't use the house personally at all in 2022.

I still say that there were no rental expenses. In #2, I said that it sounds like the repairs and fixing-up expenses were to prepare the home for sale. In #4, ManVsTax suggested that the repairs and fixing-up expenses were improvements. Since the home was never rented, there should be no rental expenses except for advertising. Even if the repairs and fixing-up expenses were to prepare the home for rental, they would not be deductible because they are start-up expenses.

It seems like there are just too many reasons why these expenses aren’t deductible.