Rental property question

[indy]

Scenario:
Resident alien has properties in India. FMV of rent is approx $200 month. Client is paying back mortgage installment in 10 years-thus huge rental losses (for the past 4-5 years). I read in Pub 535 (business expenses - not for profit activities) and it seems as though he should only be considered renting for profit if he can definitely show the assets will appreciate signifigantly to eventually show a gain. If the client can prove the rental property will appreciate enough to justify all of the losses, AND if the client plans on being in the US when this rental sells, then MAYBE he can continue taking the rental losses?
Pls help Thanks, Indy

[solomon]

Scenario:
Resident alien has properties in India. FMV of rent is approx $200 month. Client is paying back mortgage installment in 10 years-thus huge rental losses (for the past 4-5 years). I read in Pub 535 (business expenses - not for profit activities) and it seems as though he should only be considered renting for profit if he can definitely show the assets will appreciate signifigantly to eventually show a gain. If the client can prove the rental property will appreciate enough to justify all of the losses, AND if the client plans on being in the US when this rental sells, then MAYBE he can continue taking the rental losses?
Pls help Thanks, Indy

If there is a profit objective from the rental and rent is at FMR, then deductions would be allowable under §212 and appreciation would not be a factor to be demonstrated.

[indy]

section 212

Section 1.212-1(d) of the Income Tax Regulations provides that expenses, to be deductible under § 212, must be “ordinary and necessary.” Thus, such expenses must be reasonable in amount and must bear a reasonable and proximate relation to the production or collection of taxable income or to the management, conservation, or maintenance of property held for the production of income.


I believe they bought these properties knowing they will not make a profit renting them. They bought them for future appreciation. If so, wouldn't they be investment property not rental. If rental, then not for profit because they can't reasonably expect the rental to show a profit for the next several years...

[solomon]

Section 1.212-1(d) of the Income Tax Regulations provides that expenses, to be deductible under § 212, must be “ordinary and necessary.” Thus, such expenses must be reasonable in amount and must bear a reasonable and proximate relation to the production or collection of taxable income or to the management, conservation, or maintenance of property held for the production of income.


If the expenses are so high as to "not bear a reasonable and proximate relation to the production or collection of taxable income"..... ?
Is it a rental or investment property?

If annual income is $2400 and in fact is FMR, what are the annual expenses and of those expenses how much is interest?

[Davc]

Scenario:
Client is paying back mortgage installment in 10 years-thus huge rental losses (for the past 4-5 years).

Do you mean he has a 10 year mortgage or that he was behind and large amounts of accrued interest are now being paid?

[solomon]

I believe they bought these properties knowing they will not make a profit renting them. They bought them for future appreciation. If so, wouldn't they be investment property not rental. If rental, then not for profit because they can't reasonably expect the rental to show a profit for the next several years...

Not sure, but the last few pages might be useful now that you introduce §183.

http://ustaxcourt.gov/InOpHistoric/Rivera8.SUM.WPD.pdf

Personally, if there is positive cash flow adding back depreciation and interest to the bottom line, it seems to me it is a valid rental activity - but I do no know all the facts and circumstances.

By the way, if you are correct about the lack of profit motive on the rental aspect, the codification of the Economic Substance Doctrine might be relevant.

[indy]

rental....

Let me clarify something. I am only involved with this return because the IRS is auditing this client (I did not do the return). In looking over the past 3 years returns this is what I see....
Over the past few years returns he had approx 2400 in rental income from 3 different properties (800 rental from each property). He took over 8000 in mortgage interest, 300 in real estate tax and over $12000 in repairs each year. No depreciation taken for any of the properties either. When I questioned the client about the mortgage interest paid he said he was making larger payments to pay off the mortgage early. The client said rent of $60/month was reasonable for there. My thought is that at $60.month rent there is no way in hell he is ever going to make a profit. It sounds like it is merely an incidental amount of rental income that the client is incurring while holding onto investment property. Also, since he is planning on going back to India in the next few years, chances are he'll still be paying off the mortgage, and the property will still be incurring huge losses on his tax returns for the next few years. After he goes back to India he no longer has to file US tax returns, he will have written off over $150,000 in rental losses with the US never being able to recover.
Ok, I 'm done whining.

[solomon]

Let me clarify something. I am only involved with this return because the IRS is auditing this client (I did not do the return). In looking over the past 3 years returns this is what I see....
Over the past few years returns he had approx 2400 in rental income from 3 different properties (800 rental from each property). He took over 8000 in mortgage interest, 300 in real estate tax and over $12000 in repairs each year. No depreciation taken for any of the properties either. When I questioned the client about the mortgage interest paid he said he was making larger payments to pay off the mortgage early. The client said rent of $60/month was reasonable for there. My thought is that at $60.month rent there is no way in hell he is ever going to make a profit. It sounds like it is merely an incidental amount of rental income that the client is incurring while holding onto investment property. Also, since he is planning on going back to India in the next few years, chances are he'll still be paying off the mortgage, and the property will still be incurring huge losses on his tax returns for the next few years. After he goes back to India he no longer has to file US tax returns, he will have written off over $150,000 in rental losses with the US never being able to recover.
Ok, I 'm done whining.

Can you get uninvolved? My money is on the auditor.

[indy]

run away

I would love to run away form this audit, but my legs aren't fast enough!

[JohnH]

Tell him to get his checkbook out. First to pay you for your efforts and then to pay his taxes, penalties, & interest.