Stagnant Property

[Snaggletooth]

New customer. CPA has been doing returns, but moved far away.

Customer and another friend purchased tract of land along interstate some
five years ago. A partnership return (1065) has been filed every year, showing
no income, but showing property taxes and insurance as expenses. There
has been a considerable operating loss (ordinary income) shown every year,
and it has been split 50-50 on the K-1s to each partner.

My view is the operational losses should be accumulated into basis and
not deductible since there is no revenue whereby these expenses may be
offset.

Comments??

[BOB W]

New customer. CPA has been doing returns, but moved far away.

Customer and another friend purchased tract of land along interstate some
five years ago. A partnership return (1065) has been filed every year, showing
no income, but showing property taxes and insurance as expenses. There
has been a considerable operating loss (ordinary income) shown every year,
and it has been split 50-50 on the K-1s to each partner.

My view is the operational losses should be accumulated into basis and
not deductible since there is no revenue whereby these expenses may be
offset.

Comments??

I partially disagree...... I treat it like a second home for real estate taxes but would not deduct Insurance............It could all depend on the intent of the future use of the property.

[Gary2]

Intent certainly seems key.

Under some circumstances, they could be required to capitalize the real estate taxes, but I'd expect the insurance could also be capitalized in such cases. I don't see any way to deduct the insurance currently.

Are they treating the losses as passive?

[Snaggletooth]

Passive

Actually, I believe passive treatment might be the best.

However, they are clearly not at risk since they've put up all the money.

And the 1065s and K-1s show the losses as "ordinary income/loss."

Under these circumstances, is there a way to claim passive treatment?

[Gary2]

Just because it's on a K-1 as ordinary doesn't mean it's not also passive. "At risk" and "passive" are two separate concepts. If they have a mortgage or otherwise borrowed money for this, then they may not be at risk.

But you can't just skip past the "business purpose" part. You can deduct certain expenses related to a business; there's no information here suggesting a business, other than the filing of a partnership return (with no evidence of a partnership).

You can deduct certain expenses relating to investments, but limited by investment income. There's no information here suggesting that this is an investment.

You can't deduct insurance at all unless it relates to one of those specific cases where it's allowed, such as business or investment.

In general, you can deduct all real estate taxes (second home, third home, fifth home), unless it falls into one of the cases where the taxpayer is required to capitalize the taxes (e.g. a developer). This is the one the IRS is going to look for; it may hinge on documented intent as well as other information. If the partnership or any of the partners have acted like a real estate developer in the past, then the IRS may classify this as inventory, with expenses being capitalized.

[Nashville]

Going Forward

Assuming the client wants me to be involved in filing for this partnership, which of these ethical choices are preferable?

a) Insist on backfiling for last three years
b) Go forward filing partnership return essentially with zero operations and ignore
previous returns.
c) Advise client that the previous treatment was incorrect and offer to backfile (at a price, of course).

As an added note: Client and his "partner" are accustomed to deducting an operational loss from this partnership. When I don't do it, he will probably [vamoosh!!]. Remember the perception of the general public: "The best tax preparer is the one who gets you back the most money."

[luke]

I would think c. should be your choice (you cant force them to amend previous but it is your duty to advise that previous were wrong and what corrective action should be taken)