New LLC issues

[Margaret CPA in OH]

Neurosurgeon formed LLC in late 2019 for "real estate investment and creative services."  The only expense was $99 filing fee so I did nothing, LLC did nothing.  January 2020, new Ipad, phone and phone line purchased, then logo design for $600, then business checks and Google LLC GSuite so big plans.  I knew nothing of this until yesterday.

She identified a rental property to purchase for cash in July, hired a contractor for remodeling, etc. and set up ADT security.  All good so far, placed into service at market rate in January 2021.  However, July 5 charged her brother a $1000 security deposit and rent of $0 for remainder of 2020 to live in house while work was done and to supervise contractor.  So, personal days through 2020, no deductions, right?  Begin depreciation in January 2021 (new furnace December 2020), right? 

What about other expenses like the security for 6 months and soft expenses like checks, Gsuite monthly fee beginning in September, etc?  I am inclined to expense as start up costs the computer, checks, logo, etc. but begin depreciation of the rental January 2021.  But what about the monthly security expense in 2020?  Personal use?  $1000 security deposit just really early for 2021 (and I know how to handle security deposits)?  And, of course, no 1099's issued for contractor or logo design of $600.  Also, since there is no mortgage, those costs usually amortized over the life of the mortgage should be basis now, right?  It's still a faster write-off than 360 months of a 30 year mortgage.  Or should they be expensed?  Never saw this before.

I was hoping to be coasting these last couple of years but new things and new clients keep popping up and, well, I find it hard to say no, especially to someone earning $790+k.  She's only 44 but I want her to adopt me.

[Lee B]

If it was my client, all 2020 expenses would be capitalized. Are the 2020 expenses i.e., ipad, phone, phone line personal ?

[Margaret CPA in OH]

My first thought was to capitalize all that for 2020 but I'm sure she used the ipad, phone, etc. (she says all business) to search for property for rental, to arrange for inspection, for contractor, security, etc.  So those things, while leading to a rental property, were used in this part of the business actively doing so.  Why would they not be expensed as start up costs?  The rental, yes, place into service 2021, but if she was, say, looking into another type of investment (creative services, whatever that is), wouldn't they be deductible start up expenses?

This is why I am asking for input.  If you still think all should be capitalized, where is a good cite?  I was thinking that she was actively looking into investments in real estate (per articles of organization) beginning early 2020 and ended up with a rental.  It could have been some other investment, perhaps.

I am inclined to believe the ipad and phone are, indeed, for business and have asked her to confirm.  In her position, she seems to be pretty careful to not mix her medical life with anything else and has lots of money to invest.  I can well imagine that keeping business pursuits separate is important and easier to track on a separate line for messages and computer for records.  With her assets, I think it not too likely (could be wrong, though), that she is trying to commingle investment business and medical profession requirements. 

Thanks for the reply and thoughts.

[Lee B]

I don't have a problem with capitalized business start up expenses being amortized starting in January 2021.

Prior to January 2021 your client does not have any assets placed in service.

What would be the justification for deducting any expenses prior to that date?

[Lee B]

Margaret, my final thoughts on your client's situation are:

1.  The rental of one house is a passive activity, which clearly does not constitute a trade or business

2. Your client's 2020 expenses are investment related expenses not business expenses

3. If your client's activities reached the level of being a trade or business then of course they would be currently deductible.

[Margaret CPA in OH]

As I think I mentioned, her Articles of Org. state that the purpose is for 'real estate investment and creative purposes.' Is it not active business when looking into real estate investments in this case?  She finally decided on purchasing a rental property but what if the decision had been to invest in an ongoing real estate group that maybe develops properties?

I just see your last thoughts and appreciate your comments.  I will have to talk with her to see if there were any other activities which she pursued or considered that would be construed as a trade or business other than strictly a rental property.  If not, you have been very helpful in guiding my thoughts.  They are bending closer and closer to retirement!

[joanmcq]

Expenses for real estate prior to actually buying a property are not expendable prior to actually buying a property & putting it into service.  Any other “creative” types of stuff she may be maybe planning on doing also isn’t expendable because she hasn’t ‘opened the doors’ for a business.  It’s all start up costs. 

[DANRVAN]

 

8 hours ago, Margaret CPA in OH said:

Articles of Org. state that the purpose is for 'real estate investment and creative purposes.

I would not be concerned about what the Articles of Org say, they have no bearing on the actual facts and circumstance.

Clearly does not rise to the level of a trade or business.  Therefore section 195 does not apply for start up: no $5,000 or 15 year amort.

Treat is as you would any other rental.

The only catch I see here is $1,000 paid by brother. Did he actually live there full time?

I question if there is anyway to justify Schedule E income and expense for 6 months 2020?

It would not be reasonable to charge fmv rent during remodel and for overseeing contractor, but how much?

Who paid for utilities?

Did brother continue to rent in 2021?

8 hours ago, Margaret CPA in OH said:

Is it not active business when looking into real estate investments in this case?

Not in the sense of an active trade or business.

 

[Margaret CPA in OH]

All good questions and comments!  So everything is to be capitalized as rental basis?  If no amortization of startup costs, what else?  The costs are real and directly related to the business/rental.  If added to rental basis, seems a bit extreme to recover over 27.5 years. 

Yes, as noted, brother lived there full time during remodeling to monitor contractor and for security all at $0 although he did pay $1000 security deposit for fmv rental beginning January 2021.  I suspect client may have thought this was a way to begin deductions in 2020 but didn't know (or ask) about personal use by family or below market rate rent or ask about anything else, in fact, until Saturday.  Brother paid for utilities except for security.  Brother continues to live there in 2021 paying market rate rent. Client pays for ADT security only.  Brother/tenant pays all other utilities.

Thanks for comments and provoking more thoughts and questions!

[Lee B]

Well, no start up expenses.

Be sure to do some basic cost segregation and capitalize appliances, furniture and perhaps landscaping separately from the Land and Bldg.

 

[Margaret CPA in OH]

I did realize that cost seg is available and have asked for breakdown of appliances, etc. thanks.  But, if no start up expenses, where do they go?  Rental property basis doesn't seem correct but they are real, incurred in 2020, used in 2020 for this LLC only (whether strictly rental property or, eventually, other LLC activities) and will be ongoing. Thanks again for more info.