Capitalizing interest and prop taxes

[newbie]

Three member LLC was formed more than 5 years ago to purchase 60 acres w/ a building. The LLC has never filed a tax return. Intent was to rezone and resell the land commercially in its entirety or subdivided to suit prospective buyers.

The land was cleared and building rented for $2,400/ year. Interest of $18,000+/- each year and property taxes $5,600+/- has been paid on the property.

My first question is can I capitalize the interest and property taxes? Or would it be a current expense?

If election was needed to capitalize it would have been necessary on a timely filed return, which is no longer possible as they are five years too late.

[Burke]

If they never filed a tax return, how did they claim the rental income?

[newbie]

If they never filed a tax return, how did they claim the rental income?

They didn't. They did absolutely nothing. I must take this one step at a time but to start I am concerned with the expensing or capitalizing of interest and taxes.

[Burke]

For starters, file the 5 years worth of tax returns and report the income each year. Take expenses for interest & taxes on each return. You're going to have losses, which should be suspended and carried over. Net result on each 1065 is going to be zero. (Capitalize improvements to the property.) When they realize income from sales or other sources, those losses will be pulled forward and applied against income/gains.

[Jesse]

If form 1065 is required would this fall under the Small P-ships with fewer than 10 partners? Or because this is an LLC does this rule not apply?

[Jesse]

From IRS Audit Technical Guide

If property is held for future production or if it is reasonably likely that the property will be produced at a future date, pre-production costs must be capitalized. Costs of storing raw materials and carrying costs of realty held for development must be capitalized.

Real estate developers “*** must capitalize property taxes incurred with respect to property if, at the time the taxes are incurred, it is reasonably likely that the property will be subsequently developed.” See Treas. Reg. section 1.263A-2(a)(3)(ii).

In addition other pre-production expenses, including but not limited to expenses related to the following must be capitalized:

Engineering and design
Architectural plans
Securing building permits
Obtaining zoning variances
Meetings with government officials
Feasibility, environmental impact, and engineering studies
Interest Capitalization ─ IRC section 263A(f)

IRC section 263A(f) provides rules for the capitalization of interest expense during the production period of designated property. See Treas. Reg. section1.263A-8(b)(4)(I) for the De minimis “exception”. Real property and tangible personal property (that meets certain classification thresholds) is considered designated property. IRC section 263A(f)(4)(B) defines the production period as beginning on the date on which production of the property begins, and ending on the date on which the property is ready to be placed in service or is ready to be held for sale. Generally, the production period begins when physical activity is first performed. For example, the clearing of raw land, grading, excavation of foundations, etc.

I don't know if you can zero out the rental income if expenses need to be capitalized. Perhaps Burke can chime back in?

If you can net out to zero, another question, if the LLC would fall under the Small P-ships with fewer than 10 partners would past 1065's need to be filed if all partners reported their share of the income and expenses?

[ED SMITH]

When they cleared the land, they became deveIopers, so I & T have to be cap'd.

Although you could do it without a 1065, wouldn't it be much easier to track everything togther rather than to having to divide it up and carry it over on three returns each year?

[newbie]

I only have one of the three as a new client this year.

Please feel free to correct me if I'm wrong, the only other expense is insurance(which is less than the rent collected), therefore, if interest and taxes are capitalized they would have net rental income. Also if all three members did not report this rental income on their individual tax returns, Form 1065 must be filed and penalties will be assessed because the small partnership rule would not apply. If they did report on personal returns then penalties will not apply.

Can this be considered a joint venture? Or does the formation of an LLC Void this?

[newbie]

Bump to see if anyone might have any thoughts?

[Burke]

I am assuming your figures for interest and property taxes include the entire property. The bldg is the only thing rented, and it seems to me you could take the int/tax attributable to the bldg, which would more than likely wipe out the income. The rest would have to be capitalized. The real estate tax bill should show the assessment separately for the bldg/land each year. Pro-rate.