Rental issue

[appelman]

A client bought a house in 2009 in a foreclosure sale. He spent all of 2009 restoring it and didn't put it up for rent until 2010. The questions is: What to do with his 2009 expenses? I'm inclined to capitalize most of them, but what about things like travel, and utilities and insurance on the property? I wouldn't think you would want to put the property on a Schedule E until 2010. The client wouldn't get any current benefit in any case, because his income is to high to claim the rental loss. Anyone have thoughts on the best way to handle it?

[BHoffman]

Hi appelman - I think the "Available for Rent" date is when the costs go from capitalization to expense.

[JG EA]

A client bought a house in 2009 in a foreclosure sale. He spent all of 2009 restoring it and didn't put it up for rent until 2010. The questions is: What to do with his 2009 expenses? I'm inclined to capitalize most of them, but what about things like travel, and utilities and insurance on the property? I wouldn't think you would want to put the property on a Schedule E until 2010. The client wouldn't get any current benefit in any case, because his income is to high to claim the rental loss. Anyone have thoughts on the best way to handle it?

And before it was put up for rent any investment expense would be only deductible in the 2% category. As was said the renovation is capitalized, but I wouldn't say that would go for the travel, utilities, insurance. (Although there may be a case for carrying such things, but an election would have been made and added the election to the return for 2009 - usually though this carrying election is for taxes and interest, but I've seen other expenses there.)

[appelman]

I thought of taking some of those things as investment expense

But that would result in converting passive loss items to non-passive losses, albeit as miscellaneous deductions. In the present case, it would allow the client to deduct them now against ordinary income, which doesn't seem quite right. On the other hand, taxes can always be deducted on Schedule A, and in this case there is no mortgage. But what if there were?

Are you referring to a particular election procedure?

Incidentally, am I right that real estate taxes can always be claimed on Schedule A, at least as long as the property is not in service as a rental?

Thanks to both of you for your interest and thoughts.

[JG EA]

But that would result in converting passive loss items to non-passive losses, albeit as miscellaneous deductions. In the present case, it would allow the client to deduct them now against ordinary income, which doesn't seem quite right. On the other hand, taxes can always be deducted on Schedule A, and in this case there is no mortgage. But what if there were?

I am viewing this as the property was then - before it was rental property - but as property held as an investment. You can (on A 2%) deduct investment income to “manage property held for producing income”. Pub 550 Pg 36. Admittedly these three things you mention are not however listed, so read the section and see what you think. Investment interest is taken also on A (first on Form 4952)

Are you referring to a particular election procedure?

Yes, but see time limt in Pub 535 pg 21.Also note that the three items you have are not mentioned there. I've seen other carrying charges, but it has been a long time since I researched them and "remember" others being allowed, but I could be wrong about this. For a start read 525 and see what you think. I think I could find my old research on this if you would like.

TTB pg 8-6 Carrying charges include taxes and interest
paid to carry or develop real property, or to carry, transport, or
install personal property. Certain carrying charges must be capitalized
under the Uniform Capitalization Rules (see page 8-14).
Carrying charges that are not subject to UNICAP may be capitalized
or deducted currently. A taxpayer might want to make the
election (by attaching a statement to the return) to help offset a
future sale of the property that will produce substantial ordinary
income. (IRC §266)
Example: Jesse is a home construction contractor and purchases raw
land that he intends to develop into lots within the next few years. Currently,
he has no income from the land, and his tax bracket is low. Rather
than deduct interest and taxes on the land currently while he does not
need the deduction, he elects to capitalize the costs so that they will
add to the cost of goods sold deduction at a time when his income from
the sale of the lots will push him into a higher tax bracket.

Incidentally, am I right that real estate taxes can always be claimed on Schedule A, at least as long as the property is not in service as a rental?

Yes

__________________

[JG EA]

Just found this and Bees put it so much more simply and hopefully too.

http://www.thetaxbook.com/forums/showthread.php?t=1427&highlight=carrying+charges

[appelman]

But maybe my case is a little different...

If my client were "forced" to claim as investment expenses on Schedule A (by not filing a timely election), that would be the best thing that could happen to him. But maybe my case is a little different from the one discussed previously. It is fairly clearly my client's intent is to rent the property as soon as it is ready, and, in fact, he does rent it in 2010. My concern is whether intent is an important consideration, and whether the IRS might say that it was never really investment property. We would be talking about 5K on Line 23 on top of some pretty substantial employee business expenses on Line 21, and I'm not eager to raise red flags.

All insights and comments are welcome.

[appelman]

Do you really mean Pub. 525?

Yes, but see time limit in Pub 525 pg 21.Also note that the three items you have are not mentioned there. I've seen other carrying charges, but it has been a long time since I researched them and "remember" others being allowed, but I could be wrong about this. For a start read 525 and see what you think. I think I could find my old research on this if you would like.

I can't find anything relevant anywhere in Pub. 525!

[abby]

Start up expenses?

Is there any prohibition from treating these like start up expenses? He is getting ready, like any other business venture, to 'open the doors' in 2010. I would be inclined to collect these items on the balance sheet as Start Up expenses and then expense them, or otherwise treat them under the start up/org expense rules, in 2010.

[Bees Knees]

Is there any prohibition from treating these like start up expenses? He is getting ready, like any other business venture, to 'open the doors' in 2010. I would be inclined to collect these items on the balance sheet as Start Up expenses and then expense them, or otherwise treat them under the start up/org expense rules, in 2010.

Start up expenses apply to trade or business activities. An investment activity is not a trade or business. IRC Section 195(c)(1)(A)(iii) says that expenses paid in connection with an activity engaged in for profit and for the production of income can be considered start-up expenses ONLY IF it is anticipated that such activity eventually will become an active trade or business. Thus, expenses incurred in the start-up of a rental real estate activity cannot be treated as start-up expenses under Section 195 because there is no intention of operating the rental activity as a trade or business.

Without Section 195, which allows for the expensing and amortization of start-up expenses, the only alternative is to treat expenses as a capital expense, or to deduct them as investment expenses subject to the 2% AGI limitation on Schedule A.

The regulations under Section 212 (investment expenses) says that no deduction is allowed for an expense that is a capital expense. The regulations under the capital expense rules of Section 263 say that a capital expense includes:

amounts paid or incurred (1) to add to the value, or substantially prolong the useful life, of property owned by the taxpayer, such as plant or equipment, or (2) to adapt property to a new or different use. Amounts paid or incurred for incidental repairs and maintenance of property are not capital expenditures within the meaning of subparagraphs (1) and (2) of this paragraph.

Thus, for example, expenses incurred to turn the property into rental property (things that adapt the property to a new or different use) are capital expenses. Capital expenses to fix up the building are added to basis and are depreciated when the property is placed in service.

Expenses incurred for incidental repairs and maintenance (utilities bills, mowing the lawn, and similar expenses that would be incurred regardless of whether or not it was being converted to rental property) are deductible under Section 212 as investment expenses, subject to the 2% AGI limitation on Schedule A.

[abby]

ACTIVE Trade or Business, right.

Thanks, Bees for the clarification.