Tax Q: What about expenses incurred prior to purchasing?

Question

I have a couple of rental properties, 4 doors. Been at it for almost 15 years (yes, its just a side-thing, for now...). Have also been doing my own taxes the entire time. Expenses incurred to maintain, fix, service the rental are very straightforward. Even depreciation with a bit of help from Turbotax!

Now looking to get more properties, and as I spend more time and - more importantly, money, in searching for the property, the question is, what of these efforts, and how, can I deduct? Do I need to list it as separate business activity -this won't look great, as it will always have a loss - the profit only comes after the purchase! It may not even happen the same year, and after it does, is it even appropriate to expense your search efforts against the income of that property?

So for example, my latest endeavor is to try to buy a condo or in Florida to rent out (my Aunt has a lead on an old lady wanting to sell). I will need to fly down there to check the place out. It may not even work out - I may not even end up making a purchase this year! Is there a viable way to expense such a trip - and any others that come about from the efforts to acquire the property?

Michael Plaks · Answer

@Eric Stiffler

There is no simple answer to your question and, more importantly, no consensus.

As you have seen from the non-CPA replies, all investors are indignant that they are entitled to such deductions because "it is business." The only issues they are concerned about is the mechanics (like creating a general class in QB) and documenting your activities to separate business from personal. While good advice, they take for granted that you CAN deduct these expenses.

As @Ashish Acharya explained, this is not the case. You're not automatically entitled to these deductions, just because they are connected with your rental business. You have 3 very different treatments:

• deducted immediately
• capitalized and later depreciated as part of the property acquisition cost
• not deductible at all

Which one applies under which circumstances is not only complicated but also controversial. I'm certain that if Ashish and I considered 10 different scenarios for 10 different clients, we would agree on 5 and disagree on the other 5. Or maybe 8 and 2, but almost guaranteed not on all 10. There's significant room for interpretation here, not unlike in many other areas of the tax law.

Teri Feeney Styers · Answer

@Eric Stiffler I am a flipper but I think this would work for the passive income of holding as well... so when you do get with a CPA you can ask. I use Quickbooks and have a class set up for each property and an additional one called "general business". Expenses directly related to a property go in that class. General expenses like my liability umbrella policy, office supplies, etc. fall under that "general business" class. Yes, it is a negative number on the spreadsheet but is offset by the positives on the individual properties.

Eric Stiffler · Answer

Wow! What great advice here! Thank you all for your input - I did not expect this much detail! So what I have concluded is that what I am going to do is document the heck out of the trip - who, where, what, why, pics, then decide what to do with it later on. If I end up with the property, probably add it on as basis and depreciate, if not, probably include it on Schedule E - but at its also getting about time a CPA will likely be coming in to the picture too and I'll let them decide if its appropriate. Thanks again!

Alexander Szikla · Answer

Probably best to capitalize it as a closing cost and depreciate over time.

Joe Splitrock · Answer

Since you already own rental property, you can generally expense items like this against your existing property. Just be aware that it is common for people from up north to fly down south to "check out" properties and the IRS understands this is often just an attempt to expense vacations as business expenses.

You need to fully document your efforts, including meeting locations, meeting attendees and meeting times. If you are going to look at one property, then a one day trip is reasonable. Also be aware you need business purpose. If you are flying down to check it out, you should have a price, photos and high probability you plan to make an offer. People don't fly to check out a property just for the heck of it. In fact most people don't fly until they have an accepted offer. If you are staying multiple days, you need to prorate the expense to take into account personal use. Taking a four day trip to look at one condo is not reasonable, so in that case maybe 1/4 of your expense is reasonable.

That is no different than any other expense. For example, your cell phone. You only have four doors, so it is not reasonable to expense a full cell phone bill, unless you can prove that phone has no personal use. Something like maybe 50% is reasonable when you have personal use. Same with computer or any other items that have shared business and personal use. You could never expense a full automobile in your situation, but claim mileage as long as you keep good records on distance and purpose of each trip.

The trouble with Turbotax is it tells you how to calculate expense, but not if you can legitimately do it or what types of expenses are likely to get questioned by the IRS. I would be careful with only 4 doors to not have huge unreasonable expenses. That is not a substantial business, so loading it with huge expenses would make no business sense.

Ashish Acharya · Answer

Travel cost to look at other property

If you travel, but you have not identified the property that you actually want to buy yet and the cost is considered investigating cost. These costs for most of the individuals are considered personal in nature( unless you have RE portfolio that is run like a business- see below). If you had identified the property, the cost, the travel cost would be added to the basis of the property and depreciated.

These initial investigatory costs are treated differently for flipping and rentals

1) Flipping: the travel cost to investigate will be treated as a business cost and deducted as an ordinary travel cost. This is a schedule C activity if you dont have an entity. Flipping is more than likely will be considered trade or business.

2) Rentals: For this purpose, rentals are not considered trade or business, so initial inventory costs cannot be deducted as travel expenses. This travel expense is not a business expense related to the property you already own until you have identified the next property you want to buy ( once Identified costs are added to the basis as mentioned above). The reason you can't deduct travel expense before identifying property is you report your every rental activity that you already own on schedule E. The travel expense to investigate another property is not related to the activity that you already own. And you dont have schedule C to deduct the business expense.

This might have changed if your RE portfolio was run like a business, and/or you have a partnership, the partnership would then deduct the travel expense ordinary business expense.

As I said, it gets complicated really quickly. Please talk to your CPA.