Real Estate Taxes

[Bees Knees]

The standard deduction is the standard deduction. No effect. No adjustments are ever made.

Reg. Sec. 1.266-1 basically says if something is deductible, which personal residence RE taxes and mortgage interest are, then it can be capitalized if the taxpayer elects.

Really, the regulation says anything goes because under most cases it is better to deduct than to capitalize. But in those rare exceptions where the taxpayer benefits by capitalizing the costs, the regulation allows it. I think in most of your personal residence cases, electing to capitalize even when the standard deduction is higher will do little good when you consider the Section 121 exclusion on the sale of the house. That is probably why there is very little written or guidance provided on the subject.

[sea-tax]

The standard deduction is the standard deduction. No effect. No adjustments are ever made.

Reg. Sec. 1.266-1 basically says if something is deductible, which personal residence RE taxes and mortgage interest are, then it can be capitalized if the taxpayer elects.

Really, the regulation says anything goes because under most cases it is better to deduct than to capitalize. But in those rare exceptions where the taxpayer benefits by capitalizing the costs, the regulation allows it. I think in most of your personal residence cases, electing to capitalize even when the standard deduction is higher will do little good when you consider the Section 121 exclusion on the sale of the house. That is probably why there is very little written or guidance provided on the subject.

Sorry Bees I have to disagree,
While I agree that for most it is a mute point due to Section 121, I still have a lot of elderly clients who purchased a home in 60's or 70 's for less than 25k and will exceed the 500k or 250k exclusion amounts. Some times they end up paying taxes on 5-15k worth of gain. But like you said it is rare but still needed in some situations.

[Unregistered]

Bees

What's your take on this comment in Hodgkins TC Memo 1996-53? The capitals were added for emphasis. It does only address interest but I think the same comment would go for real estate taxes as well.

"Under section 266, section 263A(f), and section 189 (repealed for years after De-[pg. 96-443] cember 31, 1986), mortgage interest on IMPROVED real property is only capitalized during a period of construction or further improvement"

New York Enrolled Agent

[solomon]

1.266-1

Regs do mention a personal residence. However, no matter whether residence or not, the property whether improved or not must be in the process of development or construction. A residence in which owner was making an improvement could elect to capitalize. In no way can one accrue the taxes after construction is complete and include them year after year to increase basis.

[Bird Legs]

2004 & 2005 1040

Just had one where this would apply. Taxpayer bought a home 30 years ago,
cost 26,000. with 30,000 of improvements. Has not been able to itemize, house paid
off for several years. She, taxpayer, single, is now selling the house. Sales price,
$365,000. No sales expense, she is selling it herself. Gain of 309,000. less
Sect. 121 leaves taxable gain of $59,000. The taxes on the home were approx. 3300.
per year. By adding the taxes for the past several years to basis, would have reduced
the taxable gain considerably.
Client filed these 2 returns just this weekend.

[Bees Knees]

Bees

What's your take on this comment in Hodgkins TC Memo 1996-53? The capitals were added for emphasis. It does only address interest but I think the same comment would go for real estate taxes as well.

"Under section 266, section 263A(f), and section 189 (repealed for years after De-[pg. 96-443] cember 31, 1986), mortgage interest on IMPROVED real property is only capitalized during a period of construction or further improvement"

New York Enrolled Agent

Well, if you read that case, the court said they do not believe the taxpayer paid any of the mortgage interest. To be capitalized under Section 1.266-1, the interest would have had to have first been deductible, and since the taxpayers were not able to deduct the mortgage interest, section 1.266-1 would not apply. The taxpayers then tried to argue a different route to get credit for the phantom interest that was never really paid by claiming all kinds of capitalization rules and accruals and so forth. The case is one of obvious fraud, if you care to read the entire case. I would not hold anything in that case as usable information under normal circumstances because these guys were crooks from the git go.

[Bees Knees]

Regs do mention a personal residence. However, no matter whether residence or not, the property whether improved or not must be in the process of development or construction. A residence in which owner was making an improvement could elect to capitalize. In no way can one accrue the taxes after construction is complete and include them year after year to increase basis.

I disagree. The only limitation that applies in the reg to construction period costs are those described in Reg. Sec. 1.266-1(b)(1)(ii)(d), "other necessary expenditures, paid or incurred for the development of the real property or for the construction of an improvement or additional improvement to such real property, up to the time the development or construction work has been completed." Those expenses are "other necessary expenditures..." that are in addition to interest and taxes. Reg. Sec. 1.266-1(b)(1)(iv) says, "any other taxes and carrying charges with respect to property, otherwise deductible, which in the opinion of the Commissioner are, under sound accounting principles, chargeable to capital account.

That leaves the door open for residential property taxes and interest, even after construction or periods of improvements. There is no prohibition in writing by IRS or any other source that says otherwise.

[Unregistered]

Well, Bees, I DID read the case and I think at best your comments beg the issue and are superfluous.

I'll post a little more of what Judge Nims wrote and let everyone else draw their own conclusions. Caps added for emphasis.

"Under section 266, section 263A(f), and section 189 (repealed for years after De-[pg. 96-443] cember 31, 1986), mortgage interest on improved real property is ONLY capitalized during a period of construction or further improvement. Sec. 189(e)(2)(A) (repealed for years after December 31, 1986); sec. 1.266-1(b)(ii), Income Tax Regs.; sec. 1.263A-8(d)(3), Income Tax Regs. Petitioners failed to prove that Crow Canyon underwent a period of improvement. As already explained, petitioners substantiated only $1,763.31 of repairs on Crow Canyon. Because we do NOT believe there was a PERIOD OF IMPROVEMENT petitioners are not entitled to increase their basis by the amount of interest paid."

Reads like the judge concentrated on the issue and not fraud or whatever else is tangent to the issue about the capitalization. I'm getting the feeling Solomon is on target.

New York Enrolled Agent

[Bees Knees]

Like I said, the judge made those comments in connection with all THREE of the code sections mentioned. Section 263A could only apply during the construction or improvement phase. Section 1.266-1 cannot even be considered since the court already ruled the taxpayers never paid any interest.

Your stretching it a little bit. I wouldn't hold that case out as any precedent here.

Show me in the regulation where interest and taxes are ever limited to the construction or improvement period.

[veritas]

"Really, the regulation says anything goes because under most cases it is better to deduct than to capitalize. But in those rare exceptions where the taxpayer benefits by capitalizing the costs, the regulation allows it. I think in most of your personal residence cases, electing to capitalize even when the standard deduction is higher will do little good when you consider the Section 121 exclusion on the sale of the house. That is probably why there is very little written or guidance provided on the subject.[/QUOTE]"

Help me with the specific part of the regulation you are relying on.

[Bees Knees]

Reg. Sec. 1.266-1(b),

“(1) The taxpayer may elect, as provided in paragraph (c) of this section, to treat the items enumerated in this subparagraph which are otherwise expressly deductible under the provisions of Subtitle A of the Code as chargeable to capital account either as a component of original cost or other basis, for the purposes of section 1012, or as an adjustment to basis, for the purposes of section 1016(a)(1). The items thus chargeable to capital account are:

(i) In the case of unimproved and unproductive real property...

(ii) In the case of real property, whether improved or unimproved and whether productive or unproductive...

(iii) In the case of personal property...

(iv) Any other taxes and carrying charges with respect to property, otherwise deductible, which in the opinion of the Commissioner are, under sound accounting principles, chargeable to capital account.”

Regardless of what is mentioned in items (i) through (iii), item (iv) pretty much leaves the door open to any property that is subject to tax (real estate taxes is a tax) and carrying charges (mortgage interest is a carrying charge) that would otherwise be deductible (such as Schedule A itemized deductions for real estate tax and mortgage interest).

Reg. Sec. 1.266-1(b)(2) then goes on to say,

“The sole effect of section 266 is to permit the items enumerated in subparagraph (1) of this paragraph to be chargeable to capital account notwithstanding that such items are otherwise expressly deductible under the provisions of Subtitle A of the Code. An item not otherwise deductible may not be capitalized under section 266.”

Seems to me if they wanted to limit it to just construction and improvement periods, the statement at Section 1.266-1(b)(2) would be too overly broad for the rule.

Again, show me a regulation that says the capitalization of interest and taxes are limited to the construction or improvement period of real estate.

[veritas]

I still don't see where taxes on a constructed personal residence qualifies for the election.

(b) TAXES AND CARRYING CHARGES.

(1) The taxpayer may elect, as provided in paragraph (c) of this
section, to treat the items enumerated in this subparagraph which are
otherwise expressly deductible under the provisions of Subtitle A of
the Code as chargeable to capital account either as a component of
original cost or other basis, for the purposes of section 1012, or as
an adjustment to basis, for the purposes of section 1016(a)(1). The
items thus chargeable to capital account are:

(i) In the case of unimproved and unproductive real property:
Annual taxes, interest on a mortgage, and other carrying
charges.

(ii) In the case of real property, whether improved or
unimproved and whether productive or unproductive:

(a) Interest on a loan (but not theoretical interest of a
taxpayer using his own funds),

(b) Taxes of the owner of such real property measured by
compensation paid to his employees,

(c) Taxes of such owner imposed on the purchase of
materials, or on the storage, use, or other consumption of
materials, and

(d) Other necessary expenditures,

paid or incurred for the development of the real property or for
the construction of an improvement or additional improvement to
such real property, up to the time the development or
construction work has been completed. The development or
construction work with respect to which such items are incurred
may relate to unimproved and unproductive real estate whether
the construction work will make the property productive of
income subject to tax (as in the case of a factory) or not (as
in the case of a personal residence), or may relate to property
already improved or productive (as in the case of a plant
addition or improvement, such as the construction of another
floor on a factory or the installation of insulation therein).

(iii) In the case of personal property:

(a) Taxes of an employer measured by compensation for
services rendered in transporting machinery or other fixed
assets to the plant or installing them therein,

(b) Interest on a loan to purchase such property or to pay
for transporting or installing the same, and

(c) Taxes of the owner thereof imposed on the purchase of
such property or on the storage, use, or other consumption
of such property,

paid or incurred up to the date of installation or the date when
such property is first put into use by the taxpayer, whichever
date is later.

(iv) Any other taxes and carrying charges with respect to
property, otherwise deductible, which in the opinion of the
Commissioner are, under sound accounting principles, chargeable
to capital account.

[jainen]

I'm not a CPA

>>(iv) Any other taxes and carrying charges with respect to property, otherwise deductible, which in the opinion of the Commissioner are, under sound accounting principles, chargeable to capital account.<<

>>item (iv) pretty much leaves the door open<<

I'm not a CPA, so I'll have to defer to my more educated colleagues on this. I understand the accounting principle that allocates taxes and carrying charges to capital account during construction, but I've never heard of such for a property in use. Maybe the Commissioner has.

[Bees Knees]

I'm not a CPA, so I'll have to defer to my more educated colleagues on this. I understand the accounting principle that allocates taxes and carrying charges to capital account during construction, but I've never heard of such for a property in use. Maybe the Commissioner has.

Section 263A is basically cost accounting.

Under cost accounting rules, you capitalize an allocable portion of indirect costs which is basically your operational costs of running the business, and then recover such costs through depreciation or the cost of goods sold deduction. The indirect costs being capitalized under Section 263A all represent costs for property already in use.

[Bees Knees]

(d) Other necessary expenditures,

paid or incurred for the development of the real property or for
the construction of an improvement or additional improvement to
such real property, up to the time the development or
construction work has been completed. The development or
construction work with respect to which such items are incurred
may relate to unimproved and unproductive real estate whether
the construction work will make the property productive of
income subject to tax (as in the case of a factory) or not (as
in the case of a personal residence), or may relate to property
already improved or productive (as in the case of a plant
addition or improvement, such as the construction of another
floor on a factory or the installation of insulation therein).

My regulation book from RIA does not separate that paragraph from item (d). That paragraph appears under item (d) only as if it does not apply to items (a), (b), and (c) above. That could change the whole meaning, depending on where that paragraph is place.

Even so, item (iv) leaves the door wide open for just about anything.