Capitalizing Costs

[Kram BergGold]

My client bought a building in February 2005. He did not attmept to rent it till August 2005. During the period Feb to Aug he paid interest and taxes which I can choose to deduct as investment expenses or capitalize.
Can I capitalize the interest and deduct the taxes or must I be consistant? or
Can I deduct a tenth of the interest and capitalize the rest?
As for the utilities and insurance. Schedule A 2% deductions are probably not going to help much as he has high income. Can these be capitalized?

[Roland Slugg]

Mixed bag

Dear Kram BergGold

During the period Feb to Aug he paid interest and taxes which I can choose to deduct as investment expenses or capitalize.

The relevant Reg is §1.266-1(b)(1)(ii). This allows for the capitalization of interest, but not taxes. In my opinion the utilities and insurance may also be capitalized, under Reg §1.266-1(b)(1)(ii)(d).

The taxes could possibly also be capitalized, under Reg §1.266-1(b)(1)(iv), but this would require the assent of the Commissioner. See Reg §1.266-1(c)(2)(ii)(c). It isn't clear how the Commissioner's approval is obtained, or if it must be received in advance of taking the deduction.

Your client may pick and choose which items are expensed and which are capitalized, but he must then be consistent with respect to those items during the entire period of construction. Reg §1.266-1(c)(2)(ii)(a). Since your client's construction was completed in a single calendar year, this should not present a problem. That Reg does imply, or at least I infer, that an item must be either fully deducted or fully capitalized. I recommend a full and careful reading of Reg 1.266-1 in its entirety.

[sea-tax]

Your client may pick and choose which items are expensed and which are capitalized, but he must then be consistent with respect to those items during the entire period of construction. Reg §1.266-1(c)(2)(ii)(a). Since your client's construction was completed in a single calendar year, this should not present a problem. That Reg does imply, or at least I infer, that an item must be either fully deducted or fully capitalized. I recommend a full and careful reading of Reg 1.266-1 in its entirety.

Roland you may need to reread the post by KRAM. He said thast his client purchased the building not constructed it.I am not sure if it makes a bit of difference but it might.

Kram I would capitalize it all over the life of the property . I don't know if this is 100% correct but you are on talking a 5-6months of interest and property taxes. Plus chances are that with the way property appreciates your client will need the additional basis when he/.she sells the place.
Like I said I am sure someone will disagree but this is just my 2 cents.

[Roland Slugg]

Dear sea-tax

I can see how you might think I mis-read Kram BergGold's original post. I referred to a "period of construction" even though he did not. I made the assumption that during the six months the building was not rented that it was undergoing remodeling and/or repairs ... "construction" if you will. This assumption may not be correct but was based on what seemed like a reasonable inference.

[jainen]

what do you mean

>>capitalize it all over the life of the property<<

Sea-tax, what do you mean, "over the life of the property"? As capitalized assets, taxes and interest do not have a determinable life so they are not eligible for depreciation. They could only be recovered if and when the property is disposed of.

[Kram BergGold]

Clarification on construction

The reason the building was not rented is he was looking to sell it. There may have been some minor fix up going on but not a big deal.

[Unregistered]

Rental property or investment property?

Dear Kram BergGold

Since your client wasn't trying to rent the property for those six months, but he wasn't doing any significant remodeling or construction either, it would probably be correct to treat it as "investment property" during that period. In that case all the expenses would be deductible on Schedule A. The property taxes would be fully deductible, the interest would be subject to the F-4952 limitation, and the insurance, utilities and other ongoing expenses would be deductible as "investment expenses" subject to the 2% floor.

Did your client start renting the property in August 2005? If so, I would be inclined to treat all the expenses, including the February --> August ones, as rental expenses and deduct them on Schedule E.

[Kram BergGold]

I don't think so

What is your justification for claiming 6 months of expenses when the property was not available for rent. In this case, doing so would create a $70-90,000 loss. Sounds like an invitation for IRS examination to me.

[Unregistered]

investment

The reason the building was not rented is he was looking to sell it. There may have been some minor fix up going on but not a big deal.

BergGold--per your second post--looks like this was investment property--not rental.

[sea-tax]

>>capitalize it all over the life of the property<<

Sea-tax, what do you mean, "over the life of the property"? As capitalized assets, taxes and interest do not have a determinable life so they are not eligible for depreciation. They could only be recovered if and when the property is disposed of.

I was refering to adding the interest and property taxes to the cost basis of the building and then depreciation over the life of the building. Like I said before I didn't think it was exactly KOSHER but I thought it might work. After all it is better than expensing them all in the first year which we know is not right.