Can an estate deduct a loss on the sale of the decedent's personal residence.

• Author: Aaronson, Marc A.

The technical unit of the Brookhaven Service Center of the IRS has processed several Form 1041s, U.S. Income Tax Return for Estates and Trusts, reporting losses from the sale of a decedent's personal residence and passing those losses along to the estate's beneficiaries on Schedule K-1. The Office of Chief Counsel has issued an IRS Service Center Advice Memorandum (SCA 1998-012) in response to questions as to whether these losses are deductible, and, if so, whether they flow from the estate to the beneficiaries.

The memorandum states that, in general, an estate cannot deduct a loss on the sale of a decedent's personal residence. One reason is that an estate computes its taxable income in the same manner as an individual, and individuals may deduct only three types of losses: (1) losses incurred in a trade or business, (2) losses incurred in any transaction entered into for profit and (3) subject to certain limitations, losses from casualty or theft. The memorandum concluded that only the second provision is applicable to the sale of a decedent's personal residence (i.e., if the estate converts the residence to income-producing property). This situation is not unusual, especially when the administration of the estate is prolonged. The Chief Counsel, however, did not indicate that there could be any other situation in which a loss on the sale of a decedent's personal residence would be deductible. The memorandum states that an estate's income tax return reporting such losses should be examined to determine whether the estate converted the decedent's residence from personal property to rental property. The Service appears to be attributing a decedent's personal use of the residence to an estate; therefore, the estate's holding of the property for sale (at a profit), in the normal course of reducing the decedent's assets to cash, is not sufficient to constitute a "transaction entered into for profit." Would the IRS's position be different if an estate held the decedent's residence "for rent or for sale?"

Assuming that the estate converted the decedent's residence to rental property, and the loss is deductible, the memorandum states that if the estate is not the owner under state law, it cannot deduct the loss. When the decedent owned the personal residence as a joint tenant with right of survivorship or as a tenant by the entirety, the survivor becomes the sole owner of the property. In this situation, the loss is reported by the surviving...