## Facts

- In 1960, Stephen P. Wasnok and Mary Alice Wasnok purchased a home in Ohio, financing a substantial part of the purchase with a loan evidenced by a promissory note secured by a first mortgage held by Spring Grove Avenue Loan and Deposit Company (Spring Grove).
- In 1961, the Wasnoks moved to California and attempted to sell the Ohio home, including listing it for sale, but were unable to obtain an acceptable offer due to poor market conditions.
- Because they could not sell, they began renting the property. On June 15, 1961, they leased it for $225 per month and thereafter rented it to various tenants from 1961 through May 7, 1965, at an average monthly rent of about $200.
- The Wasnoks found tenants through advertising and referrals, and the property was repeatedly rented during this period.
- On their federal income tax returns for 1961–1964, the Wasnoks reported rental income and claimed depreciation deductions and related rental expenses for the property.
- They also made additional attempts to sell the property, including broker listings on two occasions for 90-day periods, but did not receive an offer exceeding the outstanding mortgage balance.
- By 1965, the Wasnoks could not continue making the mortgage payments. On May 7, 1965, they deeded the property to Spring Grove in satisfaction of the remaining mortgage balance of $24,421.04.
- The Wasnoks’ cost basis in the property was $32,729.70. They had claimed $4,697.42 of depreciation, resulting in an adjusted basis of $28,032.28.
- Treating the transfer as a disposition for consideration equal to the debt satisfied ($24,421.04), the Wasnoks sustained a loss of $3,611.24.
- After the disposition, they had gross income of $5,603.21 in 1965 and $3,180.00 in 1966, but did not file income tax returns for those years because they believed no tax was due.
- In 1967, they claimed a capital loss carryforward deduction of $2,000 based on the 1965 loss; in 1968, they claimed an additional capital loss carryforward of $389.
- The Commissioner disallowed the claimed capital loss carryforwards, determining that the 1965 loss was an ordinary loss fully deductible in 1965, and determined deficiencies for 1967 and 1968.

## Issues

1. Whether the 1965 loss from deeding the property to the mortgagee was a capital loss that could be carried forward and deducted in 1967 and 1968, or an ordinary loss fully deductible in 1965 because the property was used in a trade or business.

## Decision

- The Tax Court held that, during 1961–1965, the property was used as income-producing rental property and was subject to depreciation.
- Because depreciable rental real estate used in a trade or business is excluded from “capital asset” status, the loss on its disposition was not a capital loss.
- The loss was treated as an ordinary loss under the rules governing dispositions of trade-or-business property held more than one year (including § 1231 treatment).
- As a result, the loss was fully deductible in 1965 (the year sustained) and did not produce capital loss carryovers deductible in 1967 or 1968.
- The court sustained the Commissioner’s disallowance of the claimed carryforwards and the resulting deficiencies.

## Legal Principles

- “Capital asset” status under I.R.C. § 1221 excludes depreciable property used in the taxpayer’s trade or business; rental real estate held for income and depreciated falls within that exclusion.
- A residence that is converted to and operated as rental property for a sustained period, with rental income reported and depreciation claimed, may be treated as property used in a trade or business for federal tax purposes.
- Loss on the disposition of qualifying trade-or-business property held for more than one year is governed by § 1231; when the result is a net § 1231 loss, it is treated as an ordinary loss deductible in full in the year incurred.
- A loss characterized as ordinary (including a net § 1231 loss) does not generate capital loss carryovers under the capital-loss limitation and carryover provisions.

## Conclusion

The Tax Court concluded that the Wasnoks’ Ohio home had been converted to and operated as depreciable rental property for several years, making it trade-or-business property rather than a capital asset; therefore, the 1965 loss on the deed-back to the mortgagee was an ordinary § 1231 loss deductible in 1965 and could not be carried forward as a capital loss to 1967 and 1968.


Wasnok v. Commissioner, 30 T.C.M. 39 (1971)