"New" Rental Property Expense

[mactaxes]

Client purchased a residential property in June 2021 and has stated their intent is for it to be a rental property with no personal use.

After their “initial cleanup” of the property in July, August, September 2021, they decided to perform a major renovation on the house, to include additional square footage, etc., so the house has never been advertised for rent or placed in service as a rental.

They engaged a company in September 2021 for remodel plans, but due to “COVID related delays, supply chain issues and permitting problems,” they have not completed the renovation yet, over one year later.

Along with their other 2021 tax documents, they recently provided us with a spreadsheet they prepared entitled “2021 Schedule E Expenses” that they fully intend to be reported as a loss on their 2021 Schedule E including cleaning, maintenance & minor repair expense, monthly lawn maintenance, pest control, utilities, mortgage interest, property tax, hazard insurance, etc. all totaling $16K+.

Because this property has never actually been placed in service as a rental, claiming the expenses as a Schedule E rental loss for 2021 does not seem to be an option, no matter what their "intention" is. I know property tax and mortgage interest can be deducted on Schedule A. So my question then becomes: can the rest of the expenses be capitalized and added to the basis of the property? IRC Sec. 266 allows an election to capitalize expenses which "would otherwise be deductible…” And since most of the carrying costs don’t seem to be “otherwise deductible” in this case, does this mean the carrying costs go nowhere and are lost?

Before I tell the client that the majority of the expenses on this property are not deductible and cannot be capitalized, I was hoping for some feedback on whether or not I am understanding this situation correctly…

[TaxGuyBill]

In my opinion, it would be added to Basis, but by using the 'usual' rules, NOT the ?266 election.

For example, ?1.263(a)-3(d)(1) says:

Requirement to capitalize ... Amounts paid to acquire or produce a unit of real or personal property include the invoice price, transaction costs as determined under paragraph (f) of this section, and costs for work performed prior to the date that the unit of property is placed in service by the taxpayer (without regard to any applicable convention under section 168(d)).

Just like paying to install a machine would be added to Basis because it is required to be done in order to place the machine in service, so must those house-related costs be incurred in order to place the house in service. So I would add it to Basis.

[mactaxes]

Thank you TaxGuyBill for the helpful info that does seem to point in the proper direction. I appreciate the response!

[Beersheba]

I agree with all of the above, but I wonder what benefit is available for Taxes and Interest on Sch A. With the enhanced standard deduction, there may be little benefit.

And my guess is that when these taxpayers are told they cannot deduct the extra work, they may find a new tax preparer. I suppose there are still some out there that would do this, but if so they are ill-informed, or crooked.

And I'll bet all this work, delays, covid, supply chain, etc. will magically go away when they find out they have cannot deduct these costs until the unit is actually rented. May take only "days" to find a renter.