S-Corp Owning Real Estate for Investment

[JohnH]

I think this has been covered before, but I can't find it.

An S-corp bought land in a housing development for investment. The intent was to build a spec house and sell it and everybody would get rich. Unfortunately, the plan ground to a halt.

The corp financed the purchase and the shareholders are pitching in money each year to make the payments. Plus they had to refinance the original loan in 2011 since it had a balloon payment.

I bellieve the corp is required to capitalize interest, taxes, loan costs, etc. About the only deduction the corp has each year is tax prep fees and some bank charges. Is that the way others would view this?

[Snaggletooth]

Cash Drain

Yes, sounds bad John. I believe the three expenses you mention can be approached as follows:

1) Interest during construction must be capitalized. I think once the house is ready for occupancy interest may be deducted.
2) Taxes I believe are a deduction and not required to be capitalized unless there has been an election to do so. If there has been such an election, I believe it is irrevocable.
3) GAAP accounting requires front-end Loan Fees to be amortized over the course of the loan. If the loan is renewable, the fees should be amortized over the first option because there will be another round of Loan Fees with a renewal.

However, the expense created with the amortization is Interest Expense, and not the types of amortization you may deduct on Form 4625. I think this interest must follow the same deductibility as described in 1) above.

Please someone correct me if I'm wrong. I only have a confidence level of "8" on a scale of 10 and would hate for someone to depend on this. I know at one time this was correct, but I'm not necessarily up to date.

[JohnH]

I see I was a little to skimpy in the original info I posted. They never began building the house - the S-corp just owns this lot, which is mortgaged for something over $125K. The S-Corp is paying principal, interest, taxes, and HOA dues on the lot. The loan is in the name of the corp, with all the shareholders being co-signers of course.

For some reason I was thinking they were required to capitalize interest, property taxes, and HOA dues, as well as loan costs associated with the refi. The only tax deduction I see would be the ongoing costs of keeping the S-corp active - which consist mainly of accounting/tax prep fees and bank account service charges.

But I'm ready to change my mind if they can deduct any of the loan-related costs.

[Nashville]

Complexion has changed

John, about interest, the code is §460 if you can stand to read it without getting a headache.

I would say:

1) Interest is deductible because there has been no construction period yet. However, it is not operating interest, but "investment interest" and should be passed through to the investors as such. Alternatively, interest may be capitalized be election.
2) Taxes - deductible, unless capitalized by election.
3) Home Owners Association dues - deductible as an operating expense.