Can a real estate development loss be declared a NOL? (WA)

In 1999 a friend and I formed an L.L.C. and purchased a piece of property. We spent a large amount of money rennovating the two houses on the land, and we sold one house in 2002 and the second house in 2004. The project lost a large amount of money.

If the loss is declared as a long-term capital loss for our LLC on schedule K-1, my share then carries over to my personal return as a net long-term capital loss. I am thus only able to get tax benefit from this loss by playing it off against capital gains (or by taking a $3,000 loss each year if I have no gains), which puts me in the position of having to carry it forward year after year until I can manage to soak it up, which will take a long long time.

In 2002 I spoke to a tax attorney who told me that I could declare the loss as a Net Operating Loss (NOL) and thereby be able to carry the loss back to prior returns either by 5 years (because of the special provisions for 2001 & 2002 losses) or 2 years, which would allow me to soak up a substantial amount of the loss, since I had substantial income and gains in 1997-2000. I no longer have access to that tax lawyer, so I'm looking for help here.

Is it possible to declare this kind of a loss as a personal NOL? Would I need to do something special with the L.L.C.'s business returns in order for this to work? If it makes any difference, most of the loss can correctly be attributed to building expenses and mortgage interest, and not just having the real estate market go south on us.

Thank you for any help you can provide.
-L

A net operating loss exists when a business venture loses money. Were you planning to pay self-employment taxes on the gains if you made money? I didn't think so. I think you're stuck with a capital loss. However, if you can find a local tax attorney to give you an opinion letter that it's a NOL, go for it.

abezon said:

A net operating loss exists when a business venture loses money. Were you planning to pay self-employment taxes on the gains if you made money? I didn't think so. I think you're stuck with a capital loss. However, if you can find a local tax attorney to give you an opinion letter that it's a NOL, go for it.

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abezon - thanks for the quick reply! I'm still fuzzy on the NOL concept, I guess. I look at your answer and I think "we DID have a business venture, and it DID lose money!" ... but perhaps there's a formal definition of what it means for a biz venture to lose money that I'm not grasping. We certainly were expecting/hoping to pay taxes if the project made money, but the LLC wasn't paying us salaries (or self-emp taxes), so you're right about that. I don't quite get the connection there, though.

Thanks for educating me (and yes, I certainly should have been looking for this info 3 years ago)!

-LH

Business: money for services or goods. you pay self employment taxes (15%) and ordinary income taxes on net profit. you can deduct losses against ordinary income.

Investment: buy an asset & hold it hoping it will be worth more. No SE taxes on profits & profits are taxed as capital gains. losses are capital losses.

How long did you plan to keep the houses you bought & did you ever plan to rent them out? If you planned to fix up & sell quickly, it was a business. If you planned to rent for a few years until you got a favorable market, it was an investment.

thanks for more helpful info!

We definitely planned to do the renovations and sell the property as quickly as we could, and then September 11 happened and the housing market fell off (in fact the date one of the two houses went on the market was Sept 11, 2001) and they took a long time to sell. It was not our intention to just participate in an increase in market value - we were trying to make a profit by (A) subdividing the lot into two individual lots, and (B) substantially rebuilding the houses (from small abandoned cottages to 4-bedroom single family homes). Our hope was that most of our profit would come from the changes we were making to the property, and we just hoped that the market wouldn't tank while we were holding it (and we pretty much failed on both fronts).

So that's my attempt to answer the question about what our intentions were. What would/should we do differently in terms of what we file with the IRS to make the business/investment distinction? Is it just a matter of what we enter on form 1065 for the LLC?

I really appreciate you taking the time to address my questions...

-L

Sounds like a business to me. Your tax pro should know how to file the partnership return so that ordinary income is a loss.

abezon said:

Sounds like a business to me. Your tax pro should know how to file the partnership return so that ordinary income is a loss.

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You are going to have to move quickly on it though....because its going to require amending tax returns, (for the LLC as well) and you only have until April 15th to amend any 2002 returns.