If you earned considerable income from real estate during theboom years, you also paid significant taxes during those years.Selling property now at a loss creates an opportunity to recoupsome of the taxes paid in prior years. This is the silver lining inthe current market gloom, and may present opportunity for someowners: Losses could mean tax refunds.

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Real estate held by developers is treated as inventory. Adeveloper recognizes ordinary income or losses (rather than capitalgains or losses) when it sells its real property. Real estate heldas rental property or used in a trade or business by non-developersgenerates ordinary losses (called Section 1231 losses) or capitalgains when sold.

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Ordinary losses generated by sales of real property are combinedwith other income and losses of a regular corporation to determinewhether the corporation has an overall "net operating loss" for thetax year. Net operating losses may be carried back to prior yearsto decrease the tax in those prior and more profitable years. Thedecrease in tax is refunded to the taxpayer.

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Taxpayers may carryback net operating losses realized in either2008 or 2009 to the five previous tax years. The current lawprovides that net operating losses in other years may only becarried back two years prior. It is possible that Congress willagain extend the carryback period but that change is not, as of thedate of this writing, in current legislation. Any net operatinglosses left over after the carryback period may be carried forwardfor 20 years.

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It's tax law, so it's complex. This sounds straightforward sofar, but like so many things involving tax law, there arecomplexities. The passive activity loss rules may free up suspendedprior year losses on the sale of the real property. Also, ordinarylosses realized from the sale of real property by a non-developermay cause future capital gains realized from the sale of businessproperty to be characterized as ordinary income.

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Individual circumstances vary and, of course, you should seekadvice from your tax professional before you sell any real estateused or held in a trade or business. Variables affecting thisstrategy include entity type, passive activity loss rules, andrecapture of prior tax benefits.

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For example, losses realized by partnerships and S corporationsfrom the sale of real estate are passed through to the partners orshareholders. The partner or shareholder must have basis andamounts at risk in their partnership units or S corporation stockbefore the loss is allowed. Allowable losses are then nettedagainst other income of the partner or shareholder to determinewhether there is an overall net operating loss for the taxyear.

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What will happen next? Industry-wide effects may arise if largewaves of commercial properties fall upon the market. First, thevalue of all properties may decline as the available inventory inthe market increases. Second, the availability of more commercialrental space may result in falling rents that, in turn, apply morepressure to property owners. Third, lenders who reacquire realestate from the debtor-owners may face increased cash flow needs tomaintain the property.

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Commercial property owners are faced with difficult decisions inthis extraordinary time. While it may be a tough pill to swallow tosell your property at a loss, it could very well be the bestdecision for you depending on your situation.

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The views expressed in this column are those of the authorand not of ALM's Real Estate Media Group or itspublications.

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Dennis Fitzpatrick is a tax principal with Kaufman Rossin& Co. in Miami. He can be reached [email protected].

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