Loss on sale of residential property

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Section 165(c) of the United States Tax Code limits losses that taxpayers can deduct into three categories: business or trade losses, investment losses, and losses incurred from casualty or theft. A loss incurred by a taxpayer from the sale of their residential property is not deductible. Residential property losses do not fit under any of the enumerated categories under Section 165(c). Furthermore, Income Tax Regulation 1.165-9 clearly states that a loss sustained on the sale of residential property purchased or constructed by the taxpayer for use as his personal residence and so used by him up to the time of the sale is not deductible under Section 165(a).

However, if prior to the sale of the personal residence the taxpayer converts the residential property into a rental property, a loss sustained on the sale of the property will be deductible under Section 165(c)(2). To calculate the loss on residential property that was converted into a rental, prior to the sale of the property, Income Tax Regulation 1.165-9(2) states that the basis of the property will be the lesser of either the fair market value at the time of conversion or the adjusted basis determined under Section 1.1011-1.