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Capitalize or expense

27 posts by 10 users

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Real Estate Investor · Fenton, Michigan


I have brought this up on other boards, but I still am not sure of the answer. I am a landlord who has acquired some fix up properties which I will lease to tenants. I have not yet made any of the houses rent ready. The fix up procedure has gone on for three months. Do I capitalize these fix up costs or can I expense them? I think the new roof and furnace are capital improvements, but what about paint, drywall, electric outlets, PEX pipe repairs, and step repairs? I have heard from some sources that ANY expenses to get the house to rental condition must be capitalized.

Secondly in my state of Michigan property taxes are prepaid, and at closing the purchaser (me) reimburses the seller for the portion of the property taxes applicable from the closing date forward. Do I capitalize these or are they expensed?

Thank you for your answers. I want to start allocating these expenses properly now.



Residential Landlord · Chicago, Illinois


I have always understood that any expenses to make a property rent ready are capital expenses.

Property tax goes on the schedule E in the year it is paid so it is an expense.

If I am not handling correctly I'd like to know as well.



Real Estate Investor · Fenton, Michigan


Thank you for your answer.So once I rent the property to a tenant I can start to expense routine repairs and maintenance, but not before? What about when I am in between tenants? From an accounting view do you just keep putting all these expenses into the asset account, i.e. the house? That will really not give me an accurate number for what I paid for the house.



Mobile Home Investor · Spanaway, Washington


Repairs and maintenance items are deducted expenses. Only when you get into major replacements like you mentioned roof & furnace you would treat as capital improvements. If leak in the roof is fixed or furnace is cleaned & serviced or repaired - then these would go under expenses as well. If you set up a spreadsheet like the Schedule E when you pay for the item - you can put it under the right column ready to go for taxes. Use the Schedule E as a guide for setting up your Chart of Accounts.



Accountant · Lake Villa, Illinois


@Steve Might & @Dale Osborn,

Everything before the property is rent ready must be capitalized. Anything before the property is officially placed in service is simply a capital improvement.

Once the property is in service you may then deduct the repairs costs as that. When between tenants those are repairs as the property is already placed in service.

As far as accounting goes you can consider putting those in improvements to property and even depreciating that as a separate item. I prefer when the items are separately stated.

If you have any questions just put a post here and type @Steven....

-Steven the Tax Guy

Your guide to IRS laws, rules and regulations.


Small_hta_logoSteven Hamilton II, Hamilton Tax and Accounting
E-Mail: [email protected]
Telephone: (224) 381-2660
Website: http://www.HamiltonTax.Net
-Steven the Tax Guy Hamilton Tax and Accounting LLC (224) 381-2660


Real Estate Investor · Illinois


Dale is correct. All things being equal, given the choice of capitalize or expense, I would choose expense. This is following the general tax advice of "take your losses in the current year and defer income as long as possible".

An expense is recognized in the year it is taken, whereas a capitalized lost is depreciated based on the given schedule for that item.



Real Estate Investor · Fenton, Michigan


@ Steve

Steve thanks for the complete and prompt answer. Do I even capitalize the property taxes that I paid to the seller who in turn had prepaid them?

I don't think many know that these expenses should be capitalized when you first acquire the property. I don't like it, but that does appear to be the rule.



Real Estate Investor · Portland, Oregon


@Steve Might no your taxes aren't a capital expense. If you finance points though you can't take them in one year.



Mobile Home Investor · Spanaway, Washington


@Steven Hamilton II Thanks for clarifying that for me.



Accountant · Lake Villa, Illinois


@Steve Might, @Jeff S., @Mark Purtell, & @Dale Osborn

Think of anything done before the property is placed in service as your start-up costs. EVERYTHING prior to the property being placed in service (Ready for rent, meaning entirely completed and listed for rent) must be capitalized. It does not matter if it is property taxes or fixing a light switch. If it was done before the property is completed it must be capitalized and depreciated.

@Steve Might,
Because the property taxes were prepaid by him and you are reimbursing his cost, they are not accrued yet, you will expense that cost they will accrue during your ownership period.

@Mark Purtell,

I understand that you want to expense these items; however, you cannot expense something for a business that has not yet started.

@Jeff S,

Read above statement. If they are paid AFTER the placed in service date then yes they are expensed. You can pay them directly on the same day you put the "For Rent" sign out front and they can then be deducted.

Every auditor will take any expense from before the placed in service date and will try to REMOVE them from your tax return. You then must be sure to add them back in order to DEPRECIATE them.

Here is the HUD-1 Guide for where items go.
http://i1087.photobucket.com/albums/j466/StevenHamilton99/Homebasis.jpg

-Steven the Tax Guy

Your guide to IRS laws, rules and regulatiosn.


Small_hta_logoSteven Hamilton II, Hamilton Tax and Accounting
E-Mail: [email protected]
Telephone: (224) 381-2660
Website: http://www.HamiltonTax.Net
-Steven the Tax Guy Hamilton Tax and Accounting LLC (224) 381-2660


Accountant · Lake Villa, Illinois


Think of it this way:

Does it increase the value of the home?. If Yes: Depreciate, If NO: if it a structural element or increase the life of structural elements? If Yes: Depreciate. If NO: Does this replacement decrease operating costs or add new features? If Yes, Depreciate. If NO, expense.

I don't recall where I found this list but this might help. This is a list of what is typically a capital improvement. This excludes "repairing" the item. Replacement is the issue.

Additions
Bedroom
Bathroom
Deck
Garage
Porch
Patio

Heating & Air Conditioning
Heating system
Central air conditioning
Furnace
Duct work
Central humidifier
Filtration system
Lawn & Grounds
Landscaping
Driveway
Walkway
Fence
Retaining wall
Sprinkler system
Swimming pool

Miscellaneous
Storm windows, doors
New roof
Central vacuum
Wiring upgrades
Satellite dish
Security system
Plumbing
Septic system
Water heater
Soft water system
Filtration system

[b]Interior
Improvements[/b]
Built-in appliances
Kitchen modernization
Flooring
Wall-to-wall carpeting

Insulation
Attic
Walls
Floors
Pipes and duct work

This is not a finished list this is just an example. There can be other items that must be depreciated.

-Steven the Tax Guy


Small_hta_logoSteven Hamilton II, Hamilton Tax and Accounting
E-Mail: [email protected]
Telephone: (224) 381-2660
Website: http://www.HamiltonTax.Net
-Steven the Tax Guy Hamilton Tax and Accounting LLC (224) 381-2660


Real Estate Investor · Portland, Oregon


@Steven Hamilton II what I am reading on your Hud deal is taxes owed by the seller paid by the buyer is part of the purchase price and would be depreciated just as any other assumed obligation that is paid in lieu of cash. It says other taxes paid are deductible.



Real Estate Investor · Audubon, Pennsylvania


Originally posted by @Jeff S.:
@Steven Hamilton II what I am reading on your Hud deal is taxes owed by the seller paid by the buyer is part of the purchase price and would be depreciated just as any other assumed obligation that is paid in lieu of cash. It says other taxes paid are deductible.

Jeff S. - it doesn't say ALL taxes paid are deductible. It specifically states:

Originally posted by HUD1 line item list:

Line 106-107: Real Estate taxes paid in advance by seller, reimbursed by buyer: Deduct in year of purchase.

The only other deductible items from that chart are interest and insurance premiums.

My understanding is that the real estate taxes can be pro-rated for the year of purchase of a rental, splitting on the date placed in service; taxes for the period prior to being placed in service get added to basis; taxes for period after being placed in service are deductible expenses.

Let's have Steven Hamilton II confirm my understanding, or provide a correction to my explanation. I'd welcome @Dave T chiming in too ...


Steve Babiak, Redeeming Properties, LLC
Telephone: 6109082183
...


Real Estate Investor · South Carolina


Here is my quick take on the property tax question:

Prior year taxes owed by the seller but paid by the buyer as a condition of the sale, i.e. back taxes, are part of the buyer's acquisition cost and added to basis.

Taxes assessed for the year of purchase and:

1. Collected at the beginning of the year (prepaid by the seller) - are split or prorated between the buyer and the seller. The seller's portion of the taxes cover the seller's period of ownership from the beginning of the year to the date of settlement. Taxes for the portion of the year from the date of settlement to the end of the year have already been paid by the seller and are reimbursed by the buyer at settlement. The amount reimbursed is expensed by the buyer for the year of purchase.

2. Collected at the end of the year (paid in full by the buyer) - are split or prorated between the buyer and the seller. The seller's portion of the taxes cover the seller's period of ownership from the beginning of the year to the date of settlement are paid to the buyer on the HUD-1. At the end of the year, the buyer pays the entire tax bill for the year. The buyer's tax expense is the full tax bill minus the amount reimbursed by the seller.

Property taxes for the acquisiton year are not added to basis.

Just how I see it.

I am not a CPA, just a tax nerd.



Real Estate Investor · Fenton, Michigan


@ Steve B and Dave I read the same things about property taxes in NOLO's Every Landlord's Tax Deduction Guide. Steven Hamilton seems to be saying that the overriding factor is that these are expenses made to get the property to rent condition and are therefore capitalized.



Accountant · Lake Villa, Illinois


@Jeff S. and @Steve Babiak,

@Dave T is close. Very well explained although as I posted in the chart that some taxes may be required to be added to basis.

My understanding is that the real estate taxes can be pro-rated for the year of purchase of a rental, splitting on the date placed in service; taxes for the period prior to being placed in service get added to basis; taxes for period after being placed in service are deductible expenses.

@Steve Babiak, as long as it is placed in service in the year it is purchased then you may deduct the full amount that you paid.

@Steve Might, It depends upon the proper circumstances as to whether property taxes are depreciated or not. All other items have to be capitalized.

-Steven the Tax Guy

Your guide to IRS laws, rules and regulations.


Small_hta_logoSteven Hamilton II, Hamilton Tax and Accounting
E-Mail: [email protected]
Telephone: (224) 381-2660
Website: http://www.HamiltonTax.Net
-Steven the Tax Guy Hamilton Tax and Accounting LLC (224) 381-2660


Real Estate Investor · South Carolina


@Steven Hamilton II,

Seems like it should be obvious, but aren't property taxes on investment property always deductible -- Schedule A if property is held for investment use, Schedule E if property is in service as a rental? Also, for the property held for investment (not in service as rental), isn't adding the property tax to basis an option if the taxpayer does not itemize?

I don't see property taxes as a "make ready" cost for a rental. Property taxes accrue during your period of ownership and are paid regardless of whether the property is held for appreciation or for the production of income. My argument here is that the cost of making the property ready and available for rent does not depend upon paying the property taxes. Instead, the taxes are a cost of ownership that is deductible.

Am I off base?



Accountant · Lake Villa, Illinois


@Dave T,

The question is purely about the first year the property is purchased and placed in service. How the property taxes are treated initially depends upon the transaction and who paid what as I showed in that chart.

During the ordinary course of the year and holding property:
Yes, they are added to basis if they taxpayer doesn't itemize just as they are deductible on Schedule E otherwise.

In the year of purchase:
One example of this is here in Illinois, We paid 2011's property taxes in June and September of 2012.

If I purchase a house in May of 2011, I receive a credit for the 2011 property taxes from January - May. They will also give an escrow credit or actually make the tax payments before closing for 2010(payable in June and Sept of 2011).

In this case the amount that is allocated to the seller is simply added to my basis as I will not be paying the property taxes for that year.

-Steven the Tax Guy


Small_hta_logoSteven Hamilton II, Hamilton Tax and Accounting
E-Mail: [email protected]
Telephone: (224) 381-2660
Website: http://www.HamiltonTax.Net
-Steven the Tax Guy Hamilton Tax and Accounting LLC (224) 381-2660


Real Estate Investor · South Carolina


Originally posted by Steven Hamilton II:
Dave T,

If I purchase a house in May of 2011, I receive a credit for the 2011 property taxes from January - May. They will also give an escrow credit or actually make the tax payments before closing for 2010(payable in June and Sept of 2011).

In this case the amount that is allocated to the seller is simply added to my basis as I will not be paying the property taxes for that year.

OK, now I am completely confused. You, as the buyer, receive an escrow credit from the seller for property taxes that accrued to the seller. You are not actually paying the taxes at all. Either the seller has paid the taxes from the proceeds of the sale or has reimbursed you for the taxes that you will pay for his period of ownership.

You may actually pay the tax bill for the full tax year, but a portion of the money used to pay the bill did not come out of your pocket. IMO, the portion of the property tax payment that was contributed by the seller is not deductible and is not added to basis.

I still don't see how you can use the seller's contribution to the property tax bill to increase your basis.



Accountant · Lake Villa, Illinois


@Dave T,

Those taxes have not yet become due; however, they are accrued. They Seller will pay that to the buyer who will then make the actual payments. The amount of any closing credit the seller gives reduces the amount that they buyer must bring to the table; however, the taxes unpaid that will be paid by the BUYER are an addition to basis as it wasn't their cost to begin with but they are still paying it.

Look at a HUD and go through it line by line and it should make perfect sense.


Small_hta_logoSteven Hamilton II, Hamilton Tax and Accounting
E-Mail: [email protected]
Telephone: (224) 381-2660
Website: http://www.HamiltonTax.Net
-Steven the Tax Guy Hamilton Tax and Accounting LLC (224) 381-2660




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