Stephen P. Wasnok v. Commissioner
30 T.C.M. 39 (Tax Ct. 1971)

  • The Wasnoks were a married couple who owned a house in Ohio. They tried to sell the house, but the market was bad, so instead they rented it out. They rented it for four years, but couldn't rent it for enough to pay the mortgage. So they defaulted on the loan, and gave the property to the bank.
  • At the time of the loss, the Wasnoks didn't have any income, so claiming a loss on their taxes wouldn't have made a different. A few years later they had some income and so claimed the house was a long-term capital asset, and so the loss from losing the house was subject to carry-forward in subsequent tax years. The IRS disagreed.
    • The IRS argued that the loss was ordinary loss deductible only in the year it was sustained, rather than a capital loss that could be carried over from year-to-year.
      • 26 U.S.C. 1231(a)(2) says that if losses form property used in a trade or business exceed gains, then those losses should be ordinary income, not a capital loss.
    • The Wasnoks' argued that they were never engaged in a trade or business, and they only rented the house because they couldn't sell it.
  • The Tax Court found for the IRS.
    • The Tax Court found that because the Wasnoks had rented the house continuously for four years, they were in the trade or business of being a landlord, and the house was property used in that trade or business.
  • The Wasnoks were in an unusual position because most taxpayers want to have an ordinary loss, not a capital loss. But, remember, 26 U.S.C. 1211-1212 says that for each tax year, you can only deduct $3k of net capital loss, anything extra is carried forward and deductible in the next year (so if you have a $5k loss, you can deduct $3k the first year and $2k the second year). But ordinary income is not carried forward, so if you had a net adjusted gross income for a year that's less than zero, you pay no taxes this year, but you get no additional benefit the next year.