A lot of Expenses and Still paying Taxes

9 Replies

Hi guys,

I just got my taxes done by my accountant and it turns out that I have to pay over 3K for 2014 (yes I was waaayyy behind but finally got my act together and pulled everything into an accounting package). Unfortunately I'm very ignorant with my accounting and now I'm paying for it. So basically I'm going over what he sent me, I started analyzing the Schedule E that has my 3 rentals and noticed the total expenses are WAY lower than what I gave him on my reports, so below I give you the example of one of the rentals (all 3 have the same characteristic, my accountant has expenses WAY lower than what I sent him on my report):

House 1 - long term rental - Schedule E (house bought in 12/2013)

   Income: $9,346

   Expenses declared by accountant: $9,992 (this is what he somehow figured out)

   Now on the report that I gave him my total expenses are $30,300 (repairs $11,792, supplies $8,329, the rest were renovations and other stuff), so there was a lot of work on this property.

I asked him why the difference and his response was:

"I made some assumptions in the earlier years about capitalizing costs vs. repair costs. I capitalized a lot of the expenses because prior to renting you're supposed to put it into the depreciable base"

Now before responding to him I thought I have to figure out what the hell he means by this, so I went to the web and found this:

Capitalize is an accounting method used to delay the recognition of expenses by recording the expense as a long-term asset. In general, capitalizing expenses is beneficial as companies acquiring new assets with a long-term lifespan can spread out the cost.

So I guess he's recognizing about 1/3 of my expenses and the rest of the expenses he plans to deduct over time for future years? (what time period I have no idea, I guess I have to ask him). Does this make sense to you guys? Is this the way your accountant handles your expenses (including repairs) for your long term rentals?

Thank you very much in advance for any help/input. 

Roy Gutierrez

    @Roy Gutierrez , It's hard to say for sure what has happened, BUT usually "assumptions" should be discussed with a client.  

    The report that you gave him with $30k, was that related to repairs made during 2014? 

    I can make at least a dozen of assumptions based on the information you provided, but I don't like assumptions when it comes to taxes. :) 

    Can you try and provide some additional details? 

    Vlad K.

      My guess is some of this has to do with your in service date which is the date the property is rent ready. That happens after renovations are completed, so has an effect on how and what you can claim. Also keep in mind that many improvements are depreciated, so you only claim a portion of the expens for a period of years.

      I am not sure why you are so far behind on taxes, but my advice is to get your business in order. Hire a bookkeeper if you need help.

      Hi @Vlad K. ,

      Thank you very much for the feedback, I appreciate it. Yes it was related to 2014, $30,300 (repairs $11,792, supplies $8,329, the rest were renovations and other stuff). I did make 82K on my W2 that year as well and also I did have make about 4K as a 1099 for freelance computer programmer.

      I guess he's very busy, I've asked him a couple of times that I will pay him to meet with him and get my accounting in total order but he never responds. I did try to find someone else, more responsive but he was a newbie so went back to this accountant. I definitely need to sit down with an accountant and go over everything and of course willing to pay.

      Roy Gutierrez

        Thank you @Joe Splitrock ,

        I got very far behind because I was holding a very busy full time job and went into vacation rental business with multiple properties and some renovations as well, all at the same time. It was a mountain of paperwork that I had all over the place, so after I quit my job I started playing detective and putting everything together and now I'm kind at the end of the road, a little bit smarter about accounting but not enough.

        I bought the property on Mid december 2013 and after a few months renovations it was rented on 5/1/2014. I guess I have to read up on what makes an asset that depreciates (which if I remember correctly is mostly renovations) but fixes not sure, I have to ask my accountant to clarify this, his current answer doesn't give me any answers, just wanted a bit of a feedback from an investor viewpoint. 

        Roy Gutierrez

          @Roy Gutierrez When you do your research, the right keyword to use is "capitalize repairs". Basically, routine maintenance can be deducted right away but major repairs that will improve the value or prolong the life of the property needs to be capitalized. 

          Here is a good reference in determining what to capitalize (subject to depreciation) or expense (deduct right away). If you're really into reading,  here is the IRS rules for capitalization of tangible property.

          Additionally, any minor repairs done on the property prior to becoming "rent ready", need to be capitalized, these are called start up expenses and has a different accounting treatment (amortized, not depreciated). 

          In your case, either way, all work done prior to placing the property in service need to be capitalized. If the repairs done improved the value or prolonged the life of the property, it should be capitalized  as fixed asset and depreciated over period of time, if they're just minor repairs (which I don't think they were) then it should be capitalized as start up costs and amortize over period of time. 

          Hope this somehow answers your question.

          If you incurred those repair expenses BEFORE the property was placed in service, then your tax preparer is correct and they become part of the basis of the property and depreciated over the life of the property (27.5 years for residential, 39 years for commercial).

          While the communication may be lacking, the correctness of the return is probably good.  

          If those properties were already in service and you were doing remodeling between tenants, then you may want to discuss the De Minimum Safe Harbor rules with your preparer to see how much of your remodeling expenses might apply to that and how much still has to be capitalized and depreciated.

          Originally posted by @Roy Gutierrez :

          Thank you @Joe Splitrock,

          I got very far behind because I was holding a very busy full time job and went into vacation rental business with multiple properties and some renovations as well, all at the same time. It was a mountain of paperwork that I had all over the place, so after I quit my job I started playing detective and putting everything together and now I'm kind at the end of the road, a little bit smarter about accounting but not enough.

          I bought the property on Mid december 2013 and after a few months renovations it was rented on 5/1/2014. I guess I have to read up on what makes an asset that depreciates (which if I remember correctly is mostly renovations) but fixes not sure, I have to ask my accountant to clarify this, his current answer doesn't give me any answers, just wanted a bit of a feedback from an investor viewpoint. 

          This probably explains things. My guess is most of that $30K cost was incurred before the unit was put in service. Improvements like that would increase your basis cost. Some of those improvements would be added to your basis and depreciated with the structure. 

          Deprecation period depends on the category of item. Your CPA should have the deprecation tables to provide to you. 

          Look at your schedule E for 2014. Near the top section 2, it will show "Fair Rental Days". That is how many days the property was in use so will reveal your in service date. 

          Also keep in mind that depreciation starts when it is put in service, so you will not have a full years worth in 2018. Probably closer to 245 days, maybe more depending on what day you claim in service.

          Depreciation doesn't mean you miss out on the expense, it just takes years to claim it, because you are taking a portion every year.

          @Roy Gutierrez

          You said you had $9346 in income and $9992 in total expenses.  This is a tax loss on your rental property and should have reduced your total tax liability.  You are actually paying less tax on your W2 and 1099 income than you would have without the rental property.

          Even if you had $50000 in actual expenses, you don't get the full benefit of the entire expense deduction.  A rental real estate activity generally has to suspend tax losses over $25K and carry the excess forward to the next tax year. 

          If you were more familiar with the tax treatment of a residential rental activity, you would not have been so surprised by your tax return.  Suggest you read some of the free, downloadable IRS Pubs on how to report income and expenses for a rental activity.  This will help you formulate questions specific to your tax return when you speak with your accountant.

          @Roy Gutierrez

          If you spend money to get it ready for its intended use - it must be capitalized and added to basis.

          Repairs prior to 5/1/2014 should be added to basis. However, you have a good chance to deduct any repairs after this date.

          You may be able to get a better assessment from BP members if you listed exactly what was reported on schedule E. We would then be able to assess whether or not an item is missing.

          Did you provide the accountant with a copy of the HUD-1(Closing disclosure form). If he did not request it - the tax return is likely incorrect and missing valuable deductions.

          Going forward - you should attempt to have your returns completed in a timely manner. Sometimes I forget what I did last week...I can't imagine having to remember all the expenses I had 3 years ago.

          Basit Siddiqi, CPA

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