Though rental properties attract buyers who hope to gain steady income or to enjoy a high return upon their sale, tax law holds many complexities that can affect the profitability of such investments. Owners may lack awareness of the negative possibilities. Even tax advisors may not know all the potential pitfalls or ways to turn an unfavorable situation to the owners’ benefit.
Despite the pervasiveness of such transactions, professionals can find little assistance on how to allocate basis (original cost plus adjustments, improvements, casualties) and the amount realized on the sale of mixed use properties.
Practical information clarifies tax code complexities.
Using a case-study approach, Sharon Lassar, a newly-appointed associate professor in the College of Business Administration’s School of Accounting, along with two colleagues, has brought clarity to a confusing set of tax requirements related to rental property usage—a boon to tax professionals who want to make the sales implications as clear and profitable for their clients as possible.
“On the financial gain of a residence, taxpayers can exclude $250K as single filers and $500K if married—a very attractive prospect,” Lassar said. “A tax advisor will try to structure the situation to enable a person to qualify for that exclusion. However, a number of variables come into play based on the degree to which the owner has used the property. And, if the sale takes place too quickly, the owner can negate a tax advantage he or she enjoyed at the front end.”
In an article titled “Assessing the Tax Consequences of a Sale of Rental Property with Varying Degrees of Personal Usage,” published in Taxes—The Tax Magazine, a highly-regarded journal for practitioners, Lassar and her co-authors provide the needed guidance. Their fictitious property owner’s situation contains all the necessary elements to enable them to assess the consequences of six possible contingencies:
- property used solely as a principal residence
- business use of a portion of the principal residence
- personal residence with fourteen or fewer days of rental activity
- vacation home with significant personal usage (three months)
- vacation home with insignificant personal usage (one month)
- purely rental property with no personal usage
For each version of the case, Lassar and her colleagues give a thorough breakout of all the tax implications: the amount realized on the sale, the adjusted basis at the time of the sale, the realized gain, and the taxable gain, among other factors.
Not only does the article help tax advisors see the different possible scenarios, but also it enables them to propose alternatives.
“A client might experience tax benefits by making a rental his or her principal residence for two years before selling it,” Lassar said. “The concrete examples in the article help to clarify these kinds of opportunities.”
Insights come at critical time.
The article’s timeliness hinges on two factors.
“In the last decade, many people have invested in rental property,” she said. “Yet, as property taxes and carrying costs rise, a number of owners want to sell. They need to know the tax consequences if they do so. Also, the IRS has increased enforcement. More audits take place now, increasing the importance of correct reporting.”
Lassar sees such articles as an extension of her teaching, especially at the master’s level.
“This article, and others like it, focuses on real-world issues that tax experts have to understand,” she said. “Our students are already practitioners and encounter these types of scenarios in the workplace. Part of our job involves teaching them how to dissect rules and regulations to give them the necessary tools to do their jobs effectively.”
She also sees applied research as directly helpful to practitioners.
“Academics contribute to the tax field because we have the time to disentangle complicated and contradictory elements in the code and to show how to apply them efficiently in areas of unexpected complexity,” she said. “By working collaboratively, as we often do, we improve our chances of ensuring that our interpretations are correct and applicable, because we do not rely on just one set of eyes to consider such complicated requirements.”