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Selling Your Home at a Loss? The Tax Code Has Zero Sympathy

MarketDash Editorial Team
21 days ago
The IRS will happily exclude up to $500,000 in gains when you sell your primary home, but take a loss and you're on your own. Here's how the tax rules treat different types of property losses.

Here's an uncomfortable asymmetry in the tax code: sell your home for a big profit and the IRS lets married couples exclude up to $500,000 in gains. Sell at a loss and you get precisely nothing.

Your Home Isn't an Investment (According to the IRS)

The reason is brutally simple. The IRS classifies your primary residence as personal-use property, not an investment. You can't write off a loss on your couch or your car, and you can't write off a loss on the house you live in either. As falling prices and elevated borrowing costs push more homeowners underwater, tax professionals are delivering this unwelcome news more often.

The contrast is stark. The tax code gives you that generous exclusion when you win, but offers zero relief when you lose. It's a one-way bet, at least from a tax perspective.

Investment Properties Play by Different Rules

Now flip the script. If you bought a property strictly as an investment or a fix-and-flip and never lived there, the loss typically qualifies as a capital loss. That means you can use it to offset capital gains elsewhere in your portfolio. If your losses exceed your gains, you can deduct up to $3,000 per year against ordinary income and carry any excess forward indefinitely. It's the same mechanic stock investors use when they harvest tax losses, advisors at SmartAsset and Fidelity point out.

Rental properties add another layer. Hold a rental for more than a year and any loss at sale often qualifies as a Section 1231 loss, which can offset wages and other ordinary income without that $3,000 annual cap. Sounds great, except depreciation throws a wrench into the equation. Every year you own a rental, depreciation lowers your taxable income but also reduces your cost basis. The result? What feels like an economic loss can morph into a taxable gain, and part of that gain gets hit with depreciation recapture at rates up to 25%.

If you convert your former home into a rental, the IRS caps any deductible loss at the lower of your adjusted basis or the property's fair market value on the conversion date. Vacation homes you use personally stay in the personal-use category, so losses there aren't deductible either.

Documentation Decides Everything

Tax professionals at EisnerAmper, a leading U.S. accounting firm, stress that documentation makes or breaks these claims. Closing statements, receipts for improvements, depreciation schedules, and appraisals all help prove your basis if the IRS comes knocking. And because state tax rules don't always mirror federal treatment of capital losses and passive activity, planners urge anyone facing a large real estate loss to consult a local CPA before closing the deal.

Back to News

Selling Your Home at a Loss? The Tax Code Has Zero Sympathy

MarketDash Editorial Team
21 days ago
The IRS will happily exclude up to $500,000 in gains when you sell your primary home, but take a loss and you're on your own. Here's how the tax rules treat different types of property losses.

Here's an uncomfortable asymmetry in the tax code: sell your home for a big profit and the IRS lets married couples exclude up to $500,000 in gains. Sell at a loss and you get precisely nothing.

Your Home Isn't an Investment (According to the IRS)

The reason is brutally simple. The IRS classifies your primary residence as personal-use property, not an investment. You can't write off a loss on your couch or your car, and you can't write off a loss on the house you live in either. As falling prices and elevated borrowing costs push more homeowners underwater, tax professionals are delivering this unwelcome news more often.

The contrast is stark. The tax code gives you that generous exclusion when you win, but offers zero relief when you lose. It's a one-way bet, at least from a tax perspective.

Investment Properties Play by Different Rules

Now flip the script. If you bought a property strictly as an investment or a fix-and-flip and never lived there, the loss typically qualifies as a capital loss. That means you can use it to offset capital gains elsewhere in your portfolio. If your losses exceed your gains, you can deduct up to $3,000 per year against ordinary income and carry any excess forward indefinitely. It's the same mechanic stock investors use when they harvest tax losses, advisors at SmartAsset and Fidelity point out.

Rental properties add another layer. Hold a rental for more than a year and any loss at sale often qualifies as a Section 1231 loss, which can offset wages and other ordinary income without that $3,000 annual cap. Sounds great, except depreciation throws a wrench into the equation. Every year you own a rental, depreciation lowers your taxable income but also reduces your cost basis. The result? What feels like an economic loss can morph into a taxable gain, and part of that gain gets hit with depreciation recapture at rates up to 25%.

If you convert your former home into a rental, the IRS caps any deductible loss at the lower of your adjusted basis or the property's fair market value on the conversion date. Vacation homes you use personally stay in the personal-use category, so losses there aren't deductible either.

Documentation Decides Everything

Tax professionals at EisnerAmper, a leading U.S. accounting firm, stress that documentation makes or breaks these claims. Closing statements, receipts for improvements, depreciation schedules, and appraisals all help prove your basis if the IRS comes knocking. And because state tax rules don't always mirror federal treatment of capital losses and passive activity, planners urge anyone facing a large real estate loss to consult a local CPA before closing the deal.