Loss from sale of rental property previously used as principal residence

[David]

On 8/31/10, TP sold her house that was used as rental property since 9/20/08. She purchased the house on 4/21/05 and lived in it as her principal residence until 9/20/08.

She sold the house for a loss. Since the property was used as residential rental for almost 2 years does she get to deduct the full loss or does she have to prorate the loss to personal use and business use?

She lived in the house as her principal residence for 41 months and rented the house for 23 months.

I think the loss is supposed to be allocated to personal use and business use, therefore, the loss that is allocated to personal use will not be deductible.

If the loss has to be allocated to personal use and business use, how and where is this done in the ATX program? Is the allocation done on the "disposition of asset" tab on line 7 "Business use percentage"? If so, is it simply changing the 100% business use to 35.9% business use (23 months/64 months)? Or is the allocation entered somewhere else?

I don't think changing the business use from 100% is correct since 100% of the rental property is business related while it is being rented.

Thanks for your help.

[jainen]

>>does she have to prorate the loss to personal use and business use?<<

Two years is generally long enough to satisfy the requirements, assuming it was actually rented at market rates. However, the basis for gain or loss is the LESSER of FMV or adjusted basis on the date it was converted to rental. I would guess the value dropped significantly from 2005 to 2008. Yes, your client MUST get an appraisal or otherwise support that figure; if she didn't value it as a business investment then the loss is not deductible. Now reduce basis another 7% for depreciation already deducted, or even more since you apparently used the original purchase price.