Posted by Rolfe Mpls/StP on February 15, 2000 at 19:51:40:
Shane; Remember, talk to an accountant!
I know what you mean. The terms involved can get confusing. In our terms, an expense might be considered anything we spend on a rehab. Bought it for $50k, put $20k into it, sold for $100k. Made $30k. And we are right, until tax time.
If you sell the property, the IRS will treat the profit as a capital gain, and apply the capital gain tax. Capital gain equals the selling price less your aquisition costs less capital improvements (rehab). It’s a different tax form, with different rules.
If you rent the property, you depreciate your aquisition costs plus the capital improvements (the basis), not the fair market value. The cap gain is calculated whenever you sell the property.
In either case, the IRS considers “expenses” to be only business expenses, such as office supplies, auto, maintenance, and repairs. Remember the three criterea for capital improvements in my prior answer? Any building activity not covered there is considered an expense.
Often, the only real difference between the way we think and the official accounting or IRS term is symantics.
Taxes on a renovation property - Posted by Shane Cox
Posted by Shane Cox on February 15, 2000 at 08:22:57:
I need some direction as to the tax incentives for a property that I am renovating. I have put money in the property but have yet to rent it out. Can I write off any of my improvements/repairs for 1999? If I turned in my taxes already, will I lose out on any tax savings when I finally do sale/rent?
When you filed your return you should have filled out a 4562 to determine your depreciation. That is where you would have added any improvements to the cost basis of the acquisition. If you did not include then you would have to amend the return.
Repairs are deductable in the year done. Redo half the roof one year it can be called repair. Replace the whole roof then you would add it to your basis and depreciate it. Same thing on a hot water heater. Classify it as plumbing repair it is deductable. Replace and you must depreciate it.
Now for the commercial for not renting. Unless it is a house that you will have almost no vacancy you should not rent it. Unless you have the capital you need for investing without loans you should not rent it. Unless there will be no roof, AC or other major repairs in the next ten years you should not rent it.
The expectation is that you bought low and after repairs/improvements you have equity. If you sell to turn that equity into cash to invest in more property you have to pay tax on that gain. But only on the gain. You need to learn how to do it out of an IRA to postpone or eliminate taxes. First accumulate the capital needed then invest in retail property or mortgages. If you find one of those perfect deals for a rental along the way then do it. Most will not fit the criteria because you need to get your money back, it isn’t in the right location or type of property to asure yourself of no vacancy.
First, talk to your accountant. My comments are from my own experience, so you’ll want to double check. Also, pick up a copy of J.K Lasser’s “Your Income Tax Guide” Great information, updated annually. About $15.
If your improvements to the property do any ONE of the following, the improvements are considered CAPITAL improvements.
Increase the property’s useful life.
Increase the value of the property.
Change the use of the property.
If your renovation met any one of the above criteria, the cost of those improvement are not expensed, the costs are added to the property’s basis. (Basis = aquisition costs + capital improvements). The basis is used to calculate depreciation (if rental) and capital gains. To reduce cap gains, the higher the basis the better. Also, remember that cap gains tax reduces to 20% after 12 months. B4 that, cap gains are taxed at your normal income tax rate.
Re: Taxes on a renovation property - Posted by Shane Cox
Posted by Shane Cox on February 15, 2000 at 13:37:59:
I understand the concept of improvements/repair and depreciating them. However, since I’m not renting it out because of the renovation, can I deduct any depreciation/repairs on my return even though it hasn’t been rented out? Its been vacant since I bought it a year ago. Do I have to wait until I actively rent it out or sell before I can do that?
My plan is to sell after completion and reinvest the earnings in other properties or if I can’t move it then rent it out. Is your recommendation to carry the mortgage in lieu of renting supposing I can’t sell? It doesn’t sound like your a fan of renting which I agree with if at all possible. I want my money back so I can move onto other properties and build my nest egg with my gains.
Re: Capital Improvements are added basis. - Posted by Shane Cox
Posted by Shane Cox on February 15, 2000 at 14:38:08:
I’m confused slightly. My cap gains would be the difference between sale price and expenses. Right? I take your definition of basis as being the same as expenses. Increasing my basis (expenses) really becomes more of a creative matter doesn’t it? I mean, I don’t want to purchase a $100 item to simply reduce my taxes by $20. Now, I’m out $80 to save $20 unless I can incrase my sell price by more than $100 with the purchase. Correct?
The IRS has a rule about putting a property in service to start depreciating it. If you could show you advertised for rent there would not be a problem. Repairs can be deducted in the year incurred. Improvements would be added to the basis which is subtracted from the sales price when you sell. What if you submit is wrong. Will you get audited? Not likely. If you do it out of ignorance tax and interest will be assessed. Do it purposely and penalties will apply if caught.