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  1. #1
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    Feb 2005
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    Default Can You Get a Tax Deduction After Losing Real Estate to Tax Foreclosure

    My question involves real estate located in the State of: PA

    I purchased a worthless vacant residential lot over a year ago -- unknowingly, despite due diligence (I won't bore you with that saga). The property was purchased and remains in my personal name. I'm looking to transfer the property into a new LLC, stop paying the taxes on it, let it go to the County tax sale, and then take a tax loss on it.

    My question is, when does my loss for tax purposes become official? When I sell it to an LLC for $1? When it's sold at the tax sale?

    Any potential pitfalls with this plan? I've exhausted all other options.

  2. #2
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    Default Re: Can You Get a Tax Deduction After Losing Real Estate to Tax Foreclosure

    Quote Quoting beekrock
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    My question involves real estate located in the State of: PA

    I purchased a worthless vacant residential lot over a year ago -- unknowingly, despite due diligence (I won't bore you with that saga). The property was purchased and remains in my personal name. I'm looking to transfer the property into a new LLC, stop paying the taxes on it, let it go to the County tax sale, and then take a tax loss on it.

    My question is, when does my loss for tax purposes become official? When I sell it to an LLC for $1? When it's sold at the tax sale?

    Any potential pitfalls with this plan? I've exhausted all other options.
    What is your purpose in transferring it to an LLC? Will this LLC be solely owned by you?

  3. #3
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    Default Re: Can You Get a Tax Deduction After Losing Real Estate to Tax Foreclosure

    I've lost how this subterfuge generates a deductible loss at all. LLC or not, transfer or not.

  4. #4
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    Default Re: Can You Get a Tax Deduction After Losing Real Estate to Tax Foreclosure

    To keep liens or foreclosure off of my personal credit reports. Yes, solely owned LLC.

    Quote Quoting flyingron
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    I've lost how this subterfuge generates a deductible loss at all. LLC or not, transfer or not.
    The lot was acquired with the intent to flip or develop it. I would think that if it's sold for a loss it would be deemed a long term capital loss, seeing as I've had it for over a year, no?

  5. #5
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    Default Re: Can You Get a Tax Deduction After Losing Real Estate to Tax Foreclosure

    Quote Quoting beekrock
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    My question involves real estate located in the State of: PA

    I purchased a worthless vacant residential lot over a year ago -- unknowingly, despite due diligence (I won't bore you with that saga). The property was purchased and remains in my personal name. I'm looking to transfer the property into a new LLC, stop paying the taxes on it, let it go to the County tax sale, and then take a tax loss on it.

    My question is, when does my loss for tax purposes become official? When I sell it to an LLC for $1? When it's sold at the tax sale?

    Any potential pitfalls with this plan? I've exhausted all other options.
    Transferring it to a LLC will not help you at all with the tax loss. Whether you let it go it go to foreclosure with the property deeded to you or to the LLC the amount of any loss will be the same.

    Your basis in the property is whatever you paid for it. The difference between that and the fair market value or the proceeds generated by the county at the sale will determine what gain or loss you have on the disposition of the property. Bear in mind that a capital loss can only offset capital gain and, for individuals, if there is not enough capital gain to absorb the loss, you may offset up to $3,000 of the loss against ordinary income. Any excess over that must be carried forward to the next tax year.

    You might be better off trying to sell the property yourself and get whatever you can for it. If it is not enough to pay off the mortgage on it, see about arranging a short sale with the lender. Limiting your financial loss is almost always better than taking the tax loss as the tax loss will not fully compensate the financial loss you suffer.

    Note that if any portion of the mortgage debt is cancelled/discharged out of the foreclosure/short sale that discharged debt is itself taxable income unless you qualify for one of the exceptions to including it income, which for a vacant lot will come down to either the insolvency exception or, if you file bankruptcy, the bankruptcy exception.

  6. #6
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    Default Re: Can You Get a Tax Deduction After Losing Real Estate to Tax Foreclosure

    Quote Quoting Taxing Matters
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    Transferring it to a LLC will not help you at all with the tax loss. Whether you let it go it go to foreclosure with the property deeded to you or to the LLC the amount of any loss will be the same.

    Your basis in the property is whatever you paid for it. The difference between that and the fair market value or the proceeds generated by the county at the sale will determine what gain or loss you have on the disposition of the property. Bear in mind that a capital loss can only offset capital gain and, for individuals, if there is not enough capital gain to absorb the loss, you may offset up to $3,000 of the loss against ordinary income. Any excess over that must be carried forward to the next tax year.

    You might be better off trying to sell the property yourself and get whatever you can for it. If it is not enough to pay off the mortgage on it, see about arranging a short sale with the lender. Limiting your financial loss is almost always better than taking the tax loss as the tax loss will not fully compensate the financial loss you suffer.

    Note that if any portion of the mortgage debt is cancelled/discharged out of the foreclosure/short sale that discharged debt is itself taxable income unless you qualify for one of the exceptions to including it income, which for a vacant lot will come down to either the insolvency exception or, if you file bankruptcy, the bankruptcy exception.
    Thanks for the info, Taxing Matters.

    I wanted to keep the liens and tax sale foreclosure off of my credit reports and out of my personal name. My idea was to sell the lot to a corporate entity (one that would work for tax loss purposes) for $1. In this case, wouldn't $1 be the fair market value if that's what the corporate entity buys it for?

    It's been on the market for 6 months. The neighbors don't want it, the public doesn't want it, charities don't want it, and it can't be cost effectively built upon.

    I should note that I own this lot outright, unencumbered.

  7. #7
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    Default Re: Can You Get a Tax Deduction After Losing Real Estate to Tax Foreclosure

    Quote Quoting beekrock
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    Thanks for the info, Taxing Matters.

    I wanted to keep the liens and tax sale foreclosure off of my credit reports and out of my personal name. My idea was to sell the lot to a corporate entity (one that would work for tax loss purposes) for $1. In this case, wouldn't $1 be the fair market value if that's what the corporate entity buys it for?
    If you form a LLC in the U.S. with you as the sole member then for federal tax purposes that LLC is disregarded and it is treated as though you directly own the property of the LLC unless you elect for the entity to be treated as a corporation for federal tax purposes. So in your initial post, your suggestion of using a LLC does you no good for tax purposes because the property is seen for federal tax purposes as still owned by you directly. Thus the tax results are exactly the same as they would be if you simply kept the property in your own name. Transfer to the LLC might keep the tax liens off your credit report; I’ll not opine on that.

    If you form a corporation (or a LLC that you elect to be treated as a corporation) and then transfer it to the LLC for $1 the IRS is likely to say that the transfer is not really a bona fide sale at all but rather effectively a contribution of the property to the corporation in exchange for the stock of the corporation. Indeed, that is pretty much the usual result when the consideration provided is nominal and the transaction is between related parties. That sort of contribution to the corporation is tax free and you end up taking a basis in the stock equal to the basis of the property contributed to the corporation. The corporation would then have the same basis in the property that you had. The corporation will then incur any loss on the foreclosure.

    The problem is that if the corporation is a C corporation the capital loss realized can only offset any capital gain of the corporation. If you transfer if to the corporation simply for this one foreclosure event, the corporation will not have any capital gain to offset the loss and the foreclosure itself would not help you at all with reducing tax. Then you have to unload the corporate stock to realize any loss on your personal return, which is an extra needless step with potential complications that you’d not have if you simply realized the loss directly by holding the property yourself or holding through a LLC that is disregarded.

    If the corporation were a S-corporation then the result will end up effectively the same as in the LLC situation — the corporation’s loss flows through to your personal return and offsets any capital gain you have and, if loss still exists after that, up to $3,000 of ordinary income my be offset by the loss. And excess loss over that gets carried over to the next year.

    But the bottom line here is that you won’t get to gin this up as a sale to the entity for $1 to realize the loss this year before the foreclosure occurs, which is what I gather you were hoping to do. As I said initially, the amount of the ultimate loss here will end up being the same regardless of whether you hold it directly when it is foreclosed or if you transfer it to some entity you wholly own when the property is foreclosed. The timing of the loss will end up being no earlier than the year the foreclosure occurs and you lose the property. The IRS and the courts have seen many attempts by taxpayers to abuse corporate entities to gin up losses over the past century and the tax law has developed to prevent that sort of abuse.

    I suggest you keep it simple. Either keep it in your name or transfer it to a LLC that is disregarded for federal tax purposes. That will get you the loss when the tax foreclosure occurs with a minimum of cost and trouble, and if you use the LLC you may avoid a hit to the credit report. But transferring the land to a corporation (or LLC or other entity that you elect to have treated as a corporation) is a bad idea that may prevent you from taking the loss you want to take, or at least delay realization of the loss.


  8. #8
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    Default Re: Can You Get a Tax Deduction After Losing Real Estate to Tax Foreclosure

    That response couldn't have been more thorough and answered my questions exactly! Thank you so much for taking the time, Taxing Matters!

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