Sale of Investment Property

[ILLMAS]

Need help with this situation, my client bought a empty lot back in 1999, the previous tax preparer advice him not to deduct any expenses until he builds something on the lot. Well 8 years later he gave up and sold the lot, apparently he was having issues with the town and it was impossible for him to get a permit to build a house to sell or rent. His biggiest expenses are property taxes, architech fees and attorney fees, my question is if it would be okay to capitalize the property taxes, architech fees and attorney fees even though the expenses are for various years? No depreciation was calculated for the 8 years he owned it.

Thanks,

[joelgilb]

To capitalize the "Carrying Charges" on the property he needed to make an election on the initial return in the year he purchased the property. Or in any year that he wanted to start capitalizing these expenses going forward from that year. I usually attach that election each year as a safety net.

[ILLMAS]

To capitalize the "Carrying Charges" on the property he needed to make an election on the initial return in the year he purchased the property. Or in any year that he wanted to start capitalizing these expenses going forward from that year. I usually attach that election each year as a safety net.

Thanks, I forgot to mention that, he did not make no elections for the 8 years he owned it. I will talk my client and see he wants to take a chance.

[jainen]

>>see he wants to take a chance<<

Do YOU want to take a chance? You know that he did not capitalize those costs, so if he takes them now you would be signing a return in full awareness that he is deliberately understating his gain.

[joelgilb]

Unfortunate outcome, but Jainen is right, its your _ss on the line here should you sign that return.

I believe you could amend any open returns and add the election to these returns. This will at least increase the basis for the last 3 years. THe code and regs should help here - See IRC Sec 266, Regs Sec 1.266-1.

[ILLMAS]

Good point, I will definetly look into amending the last 3 years or I will recommend for him to speak to the previous tax preparer. Again, thanks for your advice.

[jainen]

>>I will definetly look into amending the last 3 years<<

To save you time, I'll point you right at Reg. Section 1.266-1( C )(3), which specifically says you can only make that election on an ORIGINAL return.

[kcjenkins]

Jainen is correct, as usual, it's a no-go. But it IS an opportunity to emphasis the value of getting quality tax advice, when making business decisions that involve taxes, as so many business decisions do. Not to knock the other preparer, who may have told him more than he 'remembered'. In fact, I'd want to look closely at the original purchase year return, to be certain that the election was not there. Because if the preparer was wise enough to give him that good advice, it seems strange that he would not have prepared the election. Remember that clients do not always remember all the details. They often just remember the part that they like hearing. And most of them would not recognize an election if they saw it in their folder.

[joelgilb]

>>I will definetly look into amending the last 3 years<<

To save you time, I'll point you right at Reg. Section 1.266-1( C )(3), which specifically says you can only make that election on an ORIGINAL return.

Thx Jainen, Good catch.

Guess I should have read more than the Master Tax Guide this time.

[jainen]

>>I should have read more than the Master Tax Guide<<

Yes. You should be reading Quickfinder instead.

[joelgilb]

>>I should have read more than the Master Tax Guide<<

Yes. You should be reading Quickfinder instead.

Interesting, it had the answer where MTG did not?. I have actually never used the Quickfinder. Guess I should start.

Usually, when I do my own research I will go to actual code, regs and cases, but to answer this one I did a quickey in the MTG.

(or quickey of another type, Definition of Quickey = 1 hour!)

[jainen]

>>it had the answer where MTG did not?<<

"Taxpayers can elect annually to capitalize taxes and interest on vacant land rather than taking a current tax deduction for the expenses [Reg. §1.266-1( B )(1)]. The election is made by filing a statement with the original return for the year the election is made. The election is effective only for the year for which it is made. The election is useful when the taxpayer does not benefit from deducting the expense, such as when itemized deductions do not exceed the standard deduction, or when investment interest expense is limited by investment income." -- Quickfinder article on Schedule A investment interest expense

Master Tax Guide does not explain HOW to make the election or WHY, but it does give a broader answer covering personal property and additional types of carrying charges during construction.

[RoyDaleOne]

Well, the fees you mentioned have to be capitalized anyway, so on that front you are okay.

[jainen]

>>the fees you mentioned have to be capitalized anyway<<

I don't think you can call this a business since what he proposed to do was not legal (unable to get permits). At any rate, he didn't treat it as a business over eight years.

That leaves it as an investment, which apparently is how he viewed it in the first place. Investment costs must be claimed annually unless you make this election we are talking about, which (as far as we know) he didn't. This case involves a construction project, so I guess the Master Tax Guide serves us better after all.

[RoyDaleOne]

Von-Lusk v. Commissioner, 104 T.C. 207

"P is a partnership organized for the purpose of managing, holding, and developing property for investment. P acquired certain raw land (the property) which it planned to subdivide. It planned to build houses on the lots of the resulting subdivision. P deducted the costs of meeting with government officials, obtaining building permits and zoning variances, negotiating permit fees, performing engineering and feasibility studies, and drafting architectural plans as "other deductions." P also deducted property taxes in respect of the property.

Sec. 263A(a) and ((1), I.R.C., precludes the deduction and provides for capitalization of direct and the allocable share of indirect costs allocable to property "produced by the taxpayer". And sec. 263A(g)(1), I.R.C., states that "The term 'PRODUCE' includes construct, build, install, manufacture, DEVELOP, or improve." (Emphasis added.)

Held, the Commissioner is sustained in disallowing deductions and requiring capitalization of the foregoing costs as well as property taxes paid by P in respect of the property, notwithstanding that P did not make any physical change to the property during the taxable years. The foregoing costs were the initial steps ancillary to actual construction of the buildings contemplated to be built. They may properly be treated as part of the development costs. Cf. Louisiana Land & Exploration Co. v. Commissioner, 7 T.C. 507 (1946), affd. 161 F.2d 842 (5th Cir. 1947). The result is not affected by the fact that local government regulations may delay or even ultimately preclude completion of the project."

I believe that this applies and the "fees", etc, should have been capitalized.

[BulldogTom]

I think Jainen is right (don't you just hate that - I would like to see him wrong every once in a while). Your tax court example RoyDaleOne looks like a business activity, even though they hold the land for investment. It seems to imply that there were multiple properties being held for investment, making the partnership a business that invested and developed land.

I think the OP implies that this is a one time investment for the taxpayer.

I could be wrong, but this appears to me to be an important distinction.

Tom

Lodi, CA

[joelgilb]

I don't know, looks to me like Roy has an interesting option here.

If the case could be made that this was a business and not an investment it might work.

[jainen]

>>they hold the land for investment<<

Although they used the word "investment," it was clearly a business activity. They filed as a business entity and deducted the expenses as necessary and ordinary costs of business. They were related to a group of dozens of partnerships that had developed real estate as a business for years. The court specifically noted that there was no question as to whether they were a business or not. So that is very different from joel's original post.

Still, I'm impressed by the scope of the regulation which applies to capital assets as well as inventory, and I thank RoyDaleOne for bringing the court ruling to our attention. I was wrong concerning the development fees, which must be capitalized in any case. Only the carrying charges such as interest and taxes were deductible annually.

[BulldogTom]

I am just casually watching this thread, but it is interesting.

The §263A code section referenced in Van-Lusk are the unicap rules. That only applies to businesses, right? Aren't you exempt from unicap if you are a small business? The §266 rules are the ones Jainen was originally quoting the regs from. Did Van-Lusk make any reference to §266? I am wondering how much scope §263A has over an individual?

Tom

Lodi, CA

[RoyDaleOne]

Regs. Sec. 1.263(a)-1. Capital expenditures; in general.

--------------------------------------------------------------------------------

(a) Except as otherwise provided in chapter 1 of the Code, no deduction

shall be allowed for:

(1) Any amount paid out for new buildings or for permanent

improvements or betterments made to increase the value of any

property or estate, or

....

See section 263A and the

regulations thereunder for cost capitalization rules that apply to amounts

referred to in paragraph (a) of this section with respect to the

production of real and tangible personal property

It is my thinking that this applies to all types property.