capitalizing real estate taxes on an investment

[JenMO]

I read you must put a statement in every year to be able to do this. What if taxpayer was not required to file in previous years? Can he still capitalize the taxes when sold?

[Roland Slugg]

That's an interesting question. Code §266 and related Regs 1.266-1 state that in order to capitalize taxes, interest and other carrying charges on unproductive real estate, that an election must be attached to an original tax return for the year capitalization is elected. The instructions for F-1040, however, as well as other IRS Pubs list all the situations when a tax return must be filed, and nowhere does it say that a tax return must be filed in order to make an election about something requiring an election.

Thus, in my opinion if a person is not otherwise required to file a return for a particular year, and does not file a return for that year ... to get a refund, for example ... then the taxes, etc., on unproductive real estate can still be capitalized. I would be very surprised if, upon audit, the IRS denied a basis increase for such carrying charges. The taxpayer, of course, would simply explain that he was not required to file returns for certain years, and if returns had been filed, the election statement would have been included in those returns.

Having said that, if you wish to be super-careful, you may wish do discuss with your client the possibility of filing a return for the sole purpose of getting the §266 election on the record.

[TaxGuyBill]

This is one of the extremely rare times I disagree with Roland, but I think that you DO need to file a tax return to capitalize it.

An election is required to capitalize it. Without an election, it is not capitalized. Without a tax return, there is not an election to capitalize.

[Roland Slugg]

I think that you DO need to file a tax return to capitalize it. An election is required to capitalize it. Without an election, it is not capitalized. Without a tax return, there is not an election to capitalize.

You may be right; I really don't know.

However, the Code (§266) and the Regs (§1.266-1) only say that the election must be made on an original return. Neither says the election must be made on a timely filed return. Thus, if the IRS denies the capitalized taxes because there was no election, the T/P can simply file returns for the missing years, including the required election in each one. To cover this possibility, the T/P may wish to prepare a return for each year when one is not otherwise required, mark it "not yet filed," then file each one if the IRS later makes an issue of it.

I really don't think IRS would contest this issue, but if it did, I believe it would drop the matter when told the missing returns will be filed if necessary.

[TaxGuyBill]

Excellent point Roland. If the tax returns are filed now (on an original return), it seems like you can capitalize the taxes.