My client purchased a beach property w/a partner in 09. They incurred some expenses with getting it ready to rent that we took in 09 on Sched E including taxes, interest. In 2010, partner was bought out and more work was done on the house to complete the furnishings, repaint, add appliances, etc. The house is on the rental program strong in 11 and has genterated about $30k in rental income in '11. I'm preaparing their '10 taxes. So, in '10 there are about $65k worth of expenses but no income until '11. Will that send a red flag to IRS? Its all correct of course. How do you handle it when alot of expenses are incurred in one or two yrs then rental income in 3rd yr? Is it safe to take depreciation expense? If so, loss could be $90k for 2010. Thank you in advance!!
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The property had to be available for rent in order to treat it as rental property and deduct expenses, not just getting it ready. Otherwise, they need to be capitalized until such time as it was rented, or was available to rent and on the market. $65K sounds like renovations. -
And a head's up
Most beach rentals rent for seven days or less. They are not considered rentals but are considered a business. So there is no 25,000 special allowance. The passive activity rules apply. Since most rentals of this type use a management company it is unlikely any loss would be allowed currently.Comment
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They are only a schedule C if the owner provides services during the time that any given renter is in residence. What are you referring to that makes this a Sch C rather than a transient rental. The fact that the owner has the place cleaned between renters does not make it a Sch C. The length of the rental and whether they use a management company does not make it a Sch C. I'm trying to understand your statement. What is your source for declaring it a business?Originally posted by veritas View PostBelieve nothing you have not personally researched and verified.Comment
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I disagree....
Originally posted by taxea View Post
Go back to this discussion - provides some good sources for you.
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It was rentable just wasn't actively being advertised. The $65k is property ins, taxes, legal fees (buy out w/partner), painting touch ups, repairs, 4 trips down there to meet with partner and attorneys, go to court, supervise painters, buying minor furnishings like grills, kitchen equipment, etc. It was rented fully starting in March 11. So, if I couldn't take these expenses in 2010, they would all go to 2011 regardless if client is cash basis?Comment
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Interesting situation
I would have a very hard time justifying $65k of "expenses" incurred in 2009/2010 for a property that was apparently never rented until the spring of 2011. Not knowing specifics, "basis" comes to mind. And when did/does the depreciation clock start??
It also sounds a bit inconsistent that the property "...was rentable just wasn't actively being advertised" while the OP states that said property has apparently generated ~$30k income during a six-month period.
Does anyone have more information about the "short-term" rental issues? I have a client who owns two condos in a beach area, and rental terms vary from one night to a couple of weeks. The high-rise management handles all rental arrangements, and basically keeps a separate "account" for each unit. The client has high income, so with the help of Form 8582 his passive losses just keep rollin' along. He does, of course, get the benefit of the "tax-free" rental income.
Are you saying that instead of filing a Sch E with the usual "rental" costs that he should instead be filing a Sch C ???? Inquiring minds would like to know more!
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While is isn't mandatory that there be demonstrable active advertising, that's usually the best proof that it was available for rent. Absent that, you will have a much more difficult time proving to the IRS that it was in service before March 11.Originally posted by Bootaxes View Post
The costs associated with buying out the partner are inherently capital. They'll have to be apportioned between the land (if any) and the structure to determine the amount that can be depreciated. Likewise, most of those minor furnishings will need to be depreciated, though not necessarily at the 27.5 year recovery period. This would be true even if all these costs were incurred after the property was first rented out. There is no 179 deduction for rentals, and without being placed in service in 2010, I don't think the bonus depreciation will be available either.
As far as I know, repairs and other items that would normally be deductible in the year paid must be capitalized if paid before the in-service date. I don't recall off the top of my head whether a rental activity (if that's what this is) is allowed to expense a portion of the start-up costs, the way a Sch. C. business can. However, that election starts phasing out at $60K, so it may be moot.
The taxes are deductible when paid, though as I recall, they must be included as part of any passive loss. I think this works to your advantage for the time frame before being placed in service, though I'd want a more experienced opinion on that question. Interest expenses are also worth more research. I don't know if the time period before being placed in service counts as investment, which would allow a deduction against other investment income, or if needs to be capitalized.
Ethically, we're not allowed to factor in the chance of an audit into any decision to take a deduction. But this is the sort of return where, if it were to be audited, the amount of work for the initial response ought to be pulling out a file, running its contents through a copier, and mailing back the copies. In other words, line up all the ducks before filing the return.Comment
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The short-term rental issue is poorly documented by the IRS, in the sense that it's documented in the wrong places. It ought to be mentioned in at least Pub. 527 and the Sch. E instructions, but as far as I know, it's only documented in Pub. 925 (Passive Activities) and in the Form 8582 instructions. The calculation seems to be based on actual rental data, so in theory, it could vary from year to year and may not be known until the end of the year. I'm not aware of any sort of safe-harbor or "n out of m year" type rule that would aid in planning and consistency.Originally posted by FEDUKE404 View Post
I'm curious. How are they getting passive losses with high income? The $25K special allowance starts phasing out at $100K (before any passive income or loss).Comment
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As for the original post I agree with Burke & Gary2.
As for the Schedule C vs. Schedule E, Facts & Circumstances will dictate and the length of the rental and whether they use a management company may very well make a difference. Take a look at this link:
Passive Activity Loss ATG - Exhibit 2.7: Vacation Rentals/Condos/B&Bs/ Hotels Reg. § 1.469-1T(e)(3)(ii) and Reg. § 1.469-5T(a)
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The same holds true
With The TaxBook. And when it refers to short term rentals the wording from page 7-12 is deficient:Originally posted by Gary2 View Post
"Not rental under passive loss rules [Reg. §1.469-1T(e)(3)].
An activity is not considered a rental activity if any
of the following apply.
• The average period of customer use of the
property is seven days or less, such as auto or
boat rental."
So one might be inclined to not think of short term rentals for condos and such.Comment
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Answer
They are not getting any passive losses, for the reason you mentioned, but they are showing goose eggs at the bottom of Sch E with the remainder of otherwise allowable losses rattling around via Form 8582 for use some time in the future.Originally posted by Gary2 View Post
My apologies for any confusion.
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So how do you prove that it was rentable if it wasn't being actively advertised?Originally posted by Bootaxes View PostBelieve nothing you have not personally researched and verified.Comment
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Here in Western NC the IRS last year did an office audit of every 2009 return with a SCH-E residential rental with $0 income and any expenses other than real estate tax and mortgage interest (assuming the TP only has 1 other home). They were adament everything else needs to be capitalized. Newspaper adverts or hiring a management company got one out of it pretty quickly, but they made us produce the documents proving the property was actually held out for rental during the year.Comment
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Okay. I have read this thread with interest, as well as the previous thread posted in 2009 referred to by Newbie, and have printed out the 2004 Passive Act Loss ATG Exhibit 2.7: Vacation Rendals/Condos/etc, and Passive Activity Loss ATG, Chapter 4 on Material Participation that Jesse mentions. So what all this is saying is, vacation rentals less than 7 days on average are considered a business; but passive if material participation rules do not apply; and it should go on Sche C? And no loss allowed? Isn't this the same result as if it were on Sche E? With suspended losses carrying to 8582 for future use?
By the same token, suppose such a rental with material participation rules satisfied due to number of hours, had losses exceeding $25K. Are you saying since it should be on Sche C, there would be no limit on such losses? (Loss primarily due to depreciation.)Last edited by Burke; 09-30-2011, 06:28 PM.Comment
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