Discussion:Repairs on Investment Property
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Discussion Forum Index --> Tax Questions --> Repairs on Investment Property
| 30 January 2006 | |
| If a person purchased a home for investment in 2005 to flip in 2006. Can he deduct the repairs made in 2005 on this tax season if the home hasn't been sold yet? | |
EDWARD RYAN (talk|edits) said: | 30 January 2006 |
| No way. | |
| 30 January 2006 | |
| Repairs on investment property would be capitalized, not expensed. | |
| January 31, 2006 | |
| Captcook - what IRC Section leads you to this conclusion? I was under the impression that repairs must be treated as deductions in the year incurred, and only "capital improvements" were capitalized into the basis (unless specifically elected otherwise). I've been searching for a long time for some justification to capitalize repairs and property taxes, so please be more specific with an IRC reference or IRS Pub #. Thanks. | |
| 1 February 2006 | |
| So even though the property haven't been sold she can still take the deduction in the year incurred. Where should I look to find out more info on this? | |
| 1 February 2006 | |
| What form do I use for this type of investment? She is not going to rent the house but after improvements are done she will sell> | |
| 1 February 2006 | |
| Improvements should be add to the cost of the property to determine your basis and once the house is sold you will file a schedule D. Capital Gains and losses. | |
| 3 February 2006 | |
| Blubby, I'm sorry I don't have time to research this and cite IRC or Pubs, but it is my understanding that because the taxpayer's intent is to prepare the asset for sale the expenses should be capitalized. If the asset were in use and the repairs were to simply maintain its condition, they would then be deductible. | |
| 3 February 2006 | |
| The only current year deductions available for investment property are mortgage interest and real estate taxes. Everything else gets added to basis until the time of sale. I am assuming there is no renter and that the property is not income-producing property. | |
| 3 February 2006 | |
| Agree that fixing up expenses need to be capitalized. Mortgage interest and real estate tax can be deducted as investment expenses but only to the extent of investment income. It would be different if this was income property like a rental but buying to flip is clearly investment. | |
| February 4, 2006 | |
| So, if real estate taxes can be deducted to the extent of investment income, and there is no income, I presume they are capitalized to basis?
This whole thread seems contradictory to a similar one titled "Real Estate Investment" dated January 10. Would anyone care to clarify, please? Perhaps if someone could cite an IRC or Pub. reference. Thanks. | |
| 4 February 2006 | |
| Expenses incurred to maintain the property in its usual state of operational readiness can be deducted if the repairs do not materially increase the value of the property or extend the useful life of the property. See Reg. Sec. 1-162-4. However, this section generally does not apply to property acquired for resale.
In all cases, restoration costs must be capitalized under Sec. 263(a)(2). In addition, all direct and indirect costs allocable to real property acquired for resale in the ordinary course of a trade or business must be capitalized under Sec. 263A(b)(2)(A). Interest need only be capitalized during the construction period. | |
| 4 February 2006 | |
| I am not 100% on this, but I believe those expenses would be reported on Sch A subject to the 2% floor. If you have the CCH MTG, see section 1085, 1086. It refers to Reg 1.212-1. Again, I'm not sure. Thoughts? | |
| 4 February 2006 | |
| The terms "investment" and "flipping" are mutually exclusive. Flippers are buying property for resale in the ordinary course of business -- in other words Sec. 1221(a) property. Sec. 212 property generally means property held for the production of income or property held for appreciation. | |
| 4 February 2006 | |
| So would this be property as described in Section 1221(a)(1)? How would that be reported? Or, would this be an investment transaction reported on Sch D? | |
Mtmckeecpa (talk|edits) said: | 4 February 2006 |
| I believe there is an election that the taxpayer can make to capitalize both interest and taxes during the improvement period. I would ask the flipper if they have investment interest income, if not much or none at all, then you may be better off electing and capitalizing interest expense. | |
| 4 February 2006 | |
| hi reg 1.162.4 repairs allows you to expense repairs provided the cost of acquisition is not increased. by inference you can therefore capitalize if it is to your advantage. irc 266 allows you to elect to capitalize carrying charges such as interest and taxes. seems to me you are better off capitalizing all to reduce your fed and state gain versus sch a misc investment exepnses bye | |
| February 4, 2006 | |
| Several points of confusion here: First, a single flip can hardly be characterized as a business or trade, so Webbtax would have to make that determination. Second, wording of Sec. 263A (referenced by Rily2, above)implies that it is applicable to ANY profit seeking activity, (not just a business or trade) but is in general reference to "inventory", so would the IRS consider a single flip house as being inventory for purposes of applying Sec. 263A? Third, is it true that the election identified by WESR must be made coincident with the return in the year the expense is incurred? Fourth, the literature is full of examples illustrating a repair as expense whereas a replacement is capital. But this is counterintuitive in that a repair will prolong an asset's useful life and increase its value, which is the definition of a capital improvement. I'm sure that Webbtax's client wouldn't be repairing the house if it were not increasing its value. Thoughts please. | |
| 4 February 2006 | |
| I agree with Blubby that the OP has to decide if his client is making an investment or whether he is engaging in a trade or business. However, that should affect the tax treatment at the time of sale rather than if these expenses should be capitalized or expensed. Whether it is determined to be investment property or inventory the repairs would have to be capitalized rather than expensed. If it was in-service rental property the answer would be different, but that is clearly not the case in this instance. | |
| 4 February 2006 | |
| For some reason, this has me confused. Now, if it is deemed to be an investment transaction, I'm assuming it gets reported on sch D with all expenses capitalized or added to the cost. Now if it's part of a trade or business, where the TP buys and sells real estate, the expenses also get capitalized? And reported on what form? | |
| 5 February 2006 | |
| Blubby, I agree that a single flip is not a trade or business unless the activity was continuous, regular, and substantial.
Sec. 263A does not apply real estate merely held for investment. Instead, it applies to real estate “produced by the taxpayer” and real estate classified as Sec. 1221(a)(1) property. Sec. 1221(a)(1) property is property held primarily for sale in the ordinary course of business. The key to understanding capitalized repairs is to understand that only “incidental” repairs that are made to maintain the property in a state of operational readiness are deductible. Example, if the taxpayer buys a home that is not fit for human habitation, the repairs made to get the property to a state of habitability would not be deducible. | |
| 5 February 2006 | |
| If a TP is in the business of buying and selling real estate, the TP's trade or business, where would this be reported? The minor repairs that you reference, where would those be deductible and the repairs to make the property habitable would be capitalized? | |
| 5 February 2006 | |
| Skhyatt: Income/expenses from a trade or business are reported on Schedule C. Selling price/basis from the sale of investments are reported on Schedule D. Capitalized costs of business inventory and investment basis do not appear on either form until the inventory/investment is sold. At that point it is deducted as Cost of Goods Sold on Schedule C or as basis on Schedule D. | |
| 5 February 2006 | |
| Allow me to make a correction to my message above. The capitalized costs of inventory do appear on Schedule C in the Cost of Goods Sold computation. However the capitalized inventory costs are not part of Cost of Goods Sold expense until the inventory is sold. | |
| February 5, 2006 | |
| Earlier in this thread, Warren said "interest and real estate tax can be deducted as investment expenses but only to the extent of investment income", but Webbtax indicated that there is no income. Since this appears to be a multi-year project, are those carrying costs capitalized to basis? If not, how can those expenses be utilized and isn't there a mismatch between revenue and expense recognition? Thanks. | |
| 5 February 2006 | |
| So then, Real Estate/homes that a TP buys for "resale" are considered part of inventory? Sounds kind of strange to think of a house as an inventory item, but that's what it would be. I guess I was thinking Sch E would be used, as for a "Real Estate Professional", but I guess that just pertains to "rental property"?? Thanks. | |
| 5 February 2006 | |
| No, real estate is not really inventory. However, real estate can be property held primarily for sale in the ordinary course of business, which is treated in the same manner as inventory under Sec. 1221(a)(1) | |
| 5 February 2006 | |
| So, would it be reported on Sch C under COGS section? As mentioned earlier. | |
| 5 February 2006 | |
| Riley2: referring back to an earlier post, you gave an example of repair expenses. In my little example here, the TP is carrying on a business of buying/selling real estate. So, TP could deduct repairs, taxes, etc on Sch C as "expenses", but for "improvements", those must be added to the basis of "inventory" in this case. Am I following correctly yet? | |
| February 5, 2006 | |
| If, in fact, the activity can be characterized as a business, I would think that the Unicap provisions would apply. Take a look at 263A to see if that is applicable. Also, referring to Riley2's earlier entry, I seem to recall a provision that expenditures, when considered COLLECTIVELY & IN AGGREGATE, result in a substantial refurbishment, prolonging of useful life or re-establishment of servicability, etc., then those expenditures must be capitalized, even though each would individualy be considered an expense on its own merits. This is the idea behind capitalizing an engine overhaul, for example. I can't honestly recall if this is IRC or GAAP, though. But if applicable, care must be given to expensing if the collective intent was to refurbish. Perhaps someone else would care to confirm? | |
| 5 February 2006 | |
| Skyhatt, once the property falls within the defintion of Sec. 1221(a)(1) property, the Sec. 263A unicap rules override the normal deductibility rules for "incidental repairs". This means that the unicap rules would force someone in the trade or business of buying and selling real esate to capitalize the repairs on any property held primarily for sale in the ordinary course of that trade or business. | |
| 5 February 2006 | |
| I would agree with the basic tenants of your statement, Blubby. If a business buys a set of sparkplugs for a company truck tuneup, its an expense. If the same sparkplugs were purchased as part of building an an engine for resale, they would be capitalized as part of the cost of the engine. Maybe not a good example, but it illustrates the basic point. | |
| 6 February 2006 | |
| Adding further to this discussion, am I reading section 263A correctly. Interest that is paid for the purchase of real property for resale is not subject to the unicap rules. Sec. 263A(f)(1)(B) and 263A(b)(1). ?? | |
| 6 February 2006 | |
| That is correct. Real property purchased for resale (and not development) is specifically not subject to he interest capitalization requirements of Sec. 263A. However, all of the other unicap rules apply to real estate purchased for resale.
The Sec. 263A(f) capitalization rules for production period interest applies only to property produced by the taxpayer [263A(b)(1) property]. Sec. 263A(f) does not apply to real property merely held for resale [Sec. 263A(b)(2) property]. | |
| February 6, 2006 | |
| Perhaps a few points in order here: First, this discussion has wandered considerably from the original question posed by Webbtax. As opposed to Skhyatt's client, Webbtax's client was NOT doing this as a business, but simply as an isolated investment, so the answers would presumably be very different. So, to Webbtax's original question, how would the treatment be different for the repairs and property taxes, etc., if this were NOT a business?
Also, as an aside, one should be aware that the phrase "produced by the taxpayer" includes property that is "improved" per 263A(g). It would be interesting to know how that term is defined for practical application. (This has been a very informative discussion...thanks to all for the insights.) | |
| 6 February 2006 | |
| I would also ask that question, how would it differ if not a business. Also, on your last point, regarding property that is improved, I'm wondering now, does that mean if a TP buys property for resale that would not be subject to the unicap rules, then "improves" it, would it then become subject to the unicap rules? | |
| 19 February 2006 | |
| I'm not good with some of these tax terms, so I'll keep this simple. I can't find the answer to the very first question. I too bought a house in 2005 for the purpose of fixing it up and flipping it. I've put several thousand dollars into it over the last several months in 2005 and Jan and Feb of 2006. Now I'm about ready to flip it. Do I need to worry about the money I spent on "fixing it up" during 2005 on my 2005 tax return...or can I just add up all the "fixing it up" money I spent on it throughout 2005 and 2006 and add that number to my basis for the house when I do my 2006 taxes? | |
| 19 February 2006 | |
| Carey: the answer is the latter. Do nothing with the "fixing up" expenses on your 2005 return. Add that number to your basis on your 2006 return. | |
| February 19, 2006 | |
| Taxref - what is the justification for this treatment, i.e. IRC, Reg., or Pub.? I cannot find anything in the regs that allow the capitalization of manitenance & repairs ("fixing-up" expenses). By my reading, it is not in 263, 263A, 266, 162, ad nauseum. I'm not saying you are wrong, I just can't find anything that allows this treatment. To the contrary, it appears to me that Carey must make an election to capitalize on the 2005 return or take the expenses as an itemized deduction in 2005, or the benefit will be lost. Please help me to understand how you come to this conclusion by citing some reference. The only way I can understand this treatment is if Carey's house flip is a continuing activity that could be deemed a business. But flipping a single house is not a business or trade. Thanks. | |
| February 19, 2006 | |
| Carey - To answer your question correctly, you need to tell us two things: (1) do you flip houses regularly, that is, would this be considered a "business"?, (2) what is the nature of your expenditures? Are they merely cosmetic and superficial, or are you making major improvements and replacements? | |
| 19 February 2006 | |
| Blubby: I wrote twice wrote long answers to your question last night, but neither recorded. If this works I'll follow with another. | |
| 19 February 2006 | |
| Well, the long answer didn't work again so let me keep it short. Repairs and Maintenance expense is one accounting concept. Costs incurred in preparing something for resale (whether investment or business) is something entirely different. You are mixing the 2 together. Review your old accounting texts rather than the tax code to clarify the concepts. Cost incurred to prepare something for resale CANNOT be taken as a current expense. After clarifying those concepts review all the answers in the top part of this thread and it should be clear. | |
| February 19, 2006 | |
| Taxref - forgive me for being dense...I did not mean to offend, just understand. Okay, so you're saying the cost an individual TP incurs to prepare an investment for resale is a capital addition, not a deductible expense. Now, what IRC or Reg says that? Please pardon my ignorance but nowhere in this discussion can I find a legitimate reference that confirms your position on this issue. I reviewed every single reference cited in this thread and they all appear to refer to a business activity or are simply erroneous citations. Please help with a reference. Thanks. | |
| 19 February 2006 | |
| Blubby:
I've corresponded with Taxref this morning and it appears that he tried to post a very detailed response to you last night, but for some reason it didn't save properly. We're not sure of the reason for this and are trying to figure out the cause and a solution. I don't think he's offended by you - just dealing with a technical issue here. - Tim Doyle, TaxAlmanac Moderator 12:30, 19 February 2006 (CST) | |
| February 19, 2006 | |
| Tim - Thanks for the heads-up.
Taxref - Many contributors, above, have voiced your same opinion. However, GAAP and IRC do no always correspond. Your position is clearly GAAP, but is it IRC also? That is my sole concern that I'm having difficulty verifying. I would feel very uncomfortable using my accounting text to justify a tax treatment to the IRS. So, there is no need to elaborate on the accounting treatment here. Based on this thread and others like it in recent months, there seems to be a lot of confusion out here on this particular topic. I appreciate your insights on this issue. | |
| 19 February 2006 | |
| Blubby: As explained by Tdoyle the reason for the terse-sounding reply above was due to the fact I lost 3 attempts to send more detailed (and much longer) responses. Hence the "just the facts" answer. | |
| February 20, 2006 | |
| Taxref: Yes, I understand. That has happened to me a few times also and it is very frustrating to lose all that work. It seems to happen to me when I spend a lot of time composing a response...seems like the system "times out". Thanks for the time you've invested. | |
HelplessTP (talk|edits) said: | 20 February 2006 |
| Does this mean that all the money I put into fixing up the house I inherited and sold can go to reduce my capital gain?.....paint, landscaping, repairs, property taxes, everything? How far back can I go? | |
| 29 June 2007 | |
| No response to HelplessTP?
I am considering buying a house as a real estate investment that was foreclosed to fix up and sell. I guess this would be a "flip." I am doing this just once and am keeping my day job :) I am trying to figure out the best way to do this. I can pay cash for the home and save some on closing and carrying costs but am wondering what I lose by doing that...yes, the liquidity of the money but are there other deductions that will make it worth having a mortgage...what would be the break even point if I do not sell this property right away? If I have to start renting it out, will it hurt me any to own it outright? Just trying to get some professional opinions if I can before I make a commitment. One of the additional questions I had pertains to HelplessTP's last post asking if "paint, landscaping, repairs, property taxes..." can all be used to reduce capital gain. This is one of the main questions I had too as one of the big improvements on the property I am interested in purchasing is landscaping. Thank you for all your help... | |
| 30 June 2007 | |
| How much are you earning on your cash? Is it more than the estimatedmortgage interest? You save the difference by not having a loan on the property. All fix-up costs will be added to initial cost to determine cost basis at time of sale. Selling price less cost basis is your profit. You will have to pay a portion of your profit to the government.If you sell it for less..you will lose money and will have to keep your day job for many more years. | |
| 30 June 2007 | |
| Shell, Hapless' situation is completely different than the typical flipper. Hapless inherited the house, he didn't buy it. Hapless should capitalize the costs and deduct his full basis when he sells the house. | |
| 9 April 2008 | |
| Taxpayer bought house in July 2007 for the purpose of renting it. Incurred various expenses to fix it up - paint, dumpster, electrical, plumbing, new cabinets, refurbished floors,- then put it up for rent in December. So the major expenses would be capitalized - roof, painting, furnace, floors- but the dumpster, clean up, utilities, mileage incurred prior to the house being "available" for rent would be expensed on schedule E? Since this is a rental and not a flip. | |
| 8 September 2009 | |
| Taxpayer paid space rent for a his investment in a mobile home while he was refurbushing it. Would the space rent be an expense subject to 2% AGI? Don't think this qualifies as an additional basis since it is an operating cost. Thx. | |
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