Tag: real estate

Uncategorized

How to write off startup cost/ expenses on a rental property.

Howard Tax Prep LLC

In our South Loop of Chicago Tax Preparation office, and our Homewood, Il tax preparation office, we often encounter taxpayers who want to generate additional revenue without having to take on a second job or a time-consuming activity. In most cases, taxpayers express an interest in becoming a commercial or residential landlord; however, prior to becoming a rent-collecting landlord, you’ll likely have to spend a lot of money researching and preparing the property for rental. The good news is that the tax code treats some of those monies as start-up expenses.

What Are Start-Up Expenses?
“Start-up expenses” are certain costs (money spent) you incur before a new business begins. In the case of a rental property business, these are costs incurred before you offer the property for rent.

Unlike operating expenses (the cost you spend on monthly bills such as internet, rent, office software etc.) for an existing business, start-up expenses can’t automatically be deducted in a single year because the money you spend to start a new rental (or any other) business is a capital expense—a cost that will benefit you for more than one year.

Normally, you can’t deduct start-up expenses until you sell or otherwise dispose of the business. But a special tax rule allows you to deduct up to $5,000 in start-up expenses the first year you are in business, with the remaining cost being deducted over the next 15 years.

There are two broad categories for startup cost:

  1. Investigatory–Cost incurred as part of a general search to determine whether to acquire or enter a new business and which new business to enter. For example, you may deduct fees paid to a market research firm to analyze the demographics, traffic patterns, and general economic conditions of a neighborhood.
  2. Pre-opening costs, such as advertising, office expenses, salaries, insurance, and maintenance costs.

Your cost of purchasing a rental property is not a start-up expense. Rental property and other long-term assets, such as furniture, must be depreciated (cost spread out over time) once the rental business begins.

On the day you start your rental business, you can elect to deduct your start-up expenses.

The deduction is equal to

  • the lesser of your start-up expenditures or $5,000, reduced (but not below zero) by the amount by which such start-up expenditures exceed $50,000, plus
  • amortization of the remaining start-up expenses over the 180-month period beginning with the month in which the rental property business begins.

When you file your tax return, you automatically elect to deduct your start-up expenses when you label and deduct them on your Schedule E (or other appropriate return).

Additionally, travel expenses to get your rental business going are deductible start-up expenses with one important exception: travel costs to buy the targeted rental property are not start-up expenses. Instead, they are capital expenses that must be added to the cost of the property and depreciated.

Costs you pay to form a partnership, limited liability company, or corporation are not part of your start-up expenses. But under a different tax rule, you can deduct up to $5,000 of these costs the first year you’re in business and amortize any remaining costs over the first 180 months you are in business.

Note that the cost of expanding an existing business is a business operating expense, not a start-up expense. As long as business expansion costs are ordinary, necessary, and within the compass of your existing rental business, they are deductible.

The IRS and tax court take the position that your rental business exists only in your property’s geographic area. So, a landlord who buys (or seeks to buy) property in a different area is starting a new rental business, which means the expenses for expanding in the new location are start-up expenses.

You can’t deduct start-up expenses if you’re a mere investor in a rental business. You must be an active rental business owner to deduct them.

Although we’ve given you the basics, this is not an all-inclusive article. Should you have questions, or need business tax preparation, business entity creation, or business compliance assistance please contact us online, or call our office at 855-743-5765. Do you owe the IRS, or your state back taxes? Do you have unfiled tax returns? Is the IRS threatening to garnish your paycheck, or levy your bank account? Are you ready to get back on track with the IRS? Howard Tax Prep LLC will help you get back on track with the IRS, get into a settlement, or setup a payment with the IRS. Reach out to us now! Make sure tojoin our newsletter for more tips on reducing taxes, and increasing your wealth.

Author information: Trudy M. Howard is a managing member of Howard Tax Prep LLC, a south loop of Chicago tax preparation and accounting office.

General Information, General Tax Topics, Small Business, Tax Deductions, Tax Planning

Make The Closing Statement Work for You When Buying Rental Property.

Howard Tax Prep LLC
Photo by Ivan Samkov on Pexels.com

In our South Loop of Chicago Tax Preparation office, and our Homewood, Il tax preparation office, we often come across taxpayers that want to reduce their tax bill and save money (legally). Because we specialize in small business owner and real estate investor tax preparation & tax planning, we often come into contact with new landlords.

Most of your purchase costs when acquiring a rental property will be detailed in the real estate closing statement or the closing disclosure. The closing statement is a financial instrument, not a tax document.

You need to go through each line item in the statement and assign it to one of the three following tax categories:

  • Basis
  • Loan Acquisition
  • Operations

Then, once you have divided your expenditures into these three categories, you often need to consider the best tax strategies for each. For example, in the basis category, you assign costs to land, land improvements, buildings, and personal property. Each dollar assignment has an impact on your profits.

This article provides a useful guide of information to help you build your rental property profits on the day you close escrow.

1. Basis

Generally, your basis (a fancy way of saying the money you put into something) is the total cost you pay for the property, including your costs of obtaining and perfecting the title. Once you have this total cost, you allocate that cost to land, land improvements, buildings, and equipment, and then you depreciate all but the land.

1.1 What Goes into Basis

Examine the closing statement to identify expenditures that you should include in your basis. The following list gives you some of the items you usually would include:

  • Contract price
  • Personal property
  • Abstract (title search) fees
  • Escrow fees
  • Legal fees (for the title search, sales contract, and deed but not for the loan)
  • Real estate commissions (generally paid by the seller; include in your basis if paid by you, the
  • buyer)
  • Recording fees
  • Surveys
  • Transfer or stamp taxes
  • Title Examination
  • Amounts you paid on behalf of the seller, such as back taxes, back interest, recording fees,
  • mortgage fees, charges for improvements and repairs, and sales commissions
  • In addition to what appears on the closing statement, make a review of your credit card statements and checkbook
  • to identify other costs that apply to the purchase of this property.

1.2 Allocating Basis to Assets

You allocate basis to land, land improvements, buildings, and equipment based on fair market values at the time of purchase.

2. Loan Acquisition

When you buy rental property, tax law divides your loan costs into two categories:

  • Costs you incur to obtain the loan
  • Costs, like points, that decrease the mortgage interest rate

2.1 Costs to Obtain the Loan

You write off the costs of obtaining the mortgage over the life of the mortgage using the straight-line amortization method. Costs you include in this write-off include:

  • Mortgage commissions
  • Abstract fees
  • Mortgage recording fees
  • Mortgage stamp and other taxes
  • Credit report
  • Lender’s inspection report
  • Appraisal fee for the loan
  • Mortgage insurance application fee
  • Mortgage assumption fee

Example. You incur $8,000 in costs to obtain a 10-year mortgage loan. You deduct $800 a year.

Loan origination fees, brokers’ fees, maximum loan charges, and premium charges are not points. These are costs of obtaining the loan and, like the costs above, you amortize them on a straight-line basis over the life of the loan.

2.2 Loan Costs That You Treat Like Interest

Points. The term “points” is often confusing. In a financial sense, the point represents a prepayment that you make to obtain a discount on the loan interest rate. In general, the more points you pay, the lower the interest rate.

Essentially, the payment of points is the payment of interest in advance, and the tax law gives special treatment to your payment of points.

Since points are nothing more than prepayment of interest on your loan, tax law treats points as original issue discount (OID). The amount of your OID determines which method you may use to write off points paid on a rental property acquisition.

3. Operating Items

At closing, you might pay real property taxes, fire and property insurance premiums, and city and town taxes. Look at these expenses. See whether they apply to your current and future holding of the property. If so, you may deduct these costs as current-year operating expenses, assuming you place the property in service at closing.

Per IRS publication 551, “If you pay real estate taxes the seller owed on real property you bought, and the seller didn’t reimburse you, treat those taxes as part of your basis. You can’t deduct them as taxes. If you reimburse the seller for taxes the seller paid for you, you can usually deduct that amount as an expense in the year of purchase.” 

You also want to look through your checkbook and credit card statements for other operating expenses and perhaps some start-up expenses.

Takeaways

The closing statement examination in this article is the perfect place to start your property on the track for maximum profits by getting the best tax benefits at inception.

When you are thinking about acquiring a rental property, make it a point to review this article so that you can get the most out of both your closing costs and your cost to buy the property.

Although we’ve given you the basics, this is not an all-inclusive article. Should you have questions, or need business tax preparation, business entity creation, or business compliance assistance please contact us online, or call our office at 855-743-5765. Do you owe the IRS, or your state back taxes? Do you have unfiled tax returns? Is the IRS threatening to garnish your paycheck, or levy your bank account? Are you ready to get back on track with the IRS? Howard Tax Prep LLC will help you get back on track with the IRS, get into a settlement, or setup a payment with the IRS. Reach out to us now! Make sure tojoin our newsletter for more tips on reducing taxes, and increasing your wealth.

Author information: Trudy M. Howard is a managing member of Howard Tax Prep LLC, a south loop of Chicago tax preparation and accounting office.