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:
- 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.
- 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.
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