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Can I use my investment property losses to offset cancellation of debt income?

August 12, 2011


From:  Ling
Date:  19 Nov 2008

Hi Michael,

Liked your web site. It answered many of my questions.

This one needs your special help:

I have an investment property that is “upside down.” Cost basis = $600k; current value = $350k, mortgage = $500k.

If I am successful in doing a short sale at $350k, I would have a loss of $250k. Can I use that to offset the cancellation of debt income of $150k?

Thanks,
Ling

Answer

Date:  4 Dec 2008

Hello Ling,

It depends.

If the property is a rental property or was used in a trade or business, the loss is called a “Section 1231 loss.” Section 1231 losses are applied first to Section 1231 gains. Net long-term Section 1231 gains are taxed as long-term capital gains (subject to special tax rates for any accumulated depreciation) and net Section 1231 losses are deductible as ordinary losses. So, if this is your only transaction and you qualify, the loss can be deducted against the cancellation of debt income.

If the property wasn’t rental property or used in a trade or business, such as a vacation home, a second home or unimproved property, the loss is either a non-deductible personal loss or a capital loss, limited to capital gains plus $3,000. In this case, you won’t get an offset against your cancellation of debt income.

Good luck!
Mike Gray

We have more answers to frequently asked real estate tax questions! We also offer up-to-date information about new tax real estate tax developments in Michael Gray, CPA's Real Estate Tax Letter.

IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained on this website was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.

Can I use my investment property losses to offset cancellation of debt income?

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