A new client of mine came in with his past tax returns. He had over $70,000 in investment interest expense that was being carrying forward on a property he had sold at a $20,000 loss.
The real estate investment was actually bare land. He had a loan on the property and rather than capitalizing the interest expense into basis (as should have been done), the prior tax preparer had called it investment interest expense. That would only have been deductible if there was investment income. He didn’t have any. So the expense was just suspended for a future day when he had investment income to offset it.
On the other hand, if it had been capitalized like it should have been, it would have increased basis. Increased basis means less gain or more loss when the property sells. So, that was the first thing to fix.
Next, we looked at the lot sale itself. With the increased basis, there was now a loss of $90,000 when he sold the property. Since the property wasn’t yet been put in service, it’s a capital asset. That means any gain would have been subject to capital gains (good) and any loss is subject to capital loss rules (bad).
Without any capital gains to offset his capital loss against, the loss is just deductible at $3,000 per year. Since he’s got $90,000 of loss, he’s going to be writing that off for 30 years unless he has a big capital gain to offset most of it.
The difference between a capital asset you sell and a business real estate property you sell is whether you have put the property in service.
How could he put the property in service? Well, it turns out he already had but he didn’t realize the importance reporting it. So, he’d never bothered to tell anyone.
He had rented a place on the property for sign placement for $500 a year. Mowing the lot cost $480 per year, and he just never bothered to report the $20 of net income he was receiving.
By not reporting it, and not telling anyone about it, he had a capital property that was not in service. That meant the deduction for the loss was limited to $3,000 a year. If he had reported that it was in service (as it was), the entire loss would have been allowable to offset his other income right now. If he had sold the property at a gain, he would have received capital gains treatment. It’s the best of all worlds – lower capital gains tax treatment if it sells at a profit and fully deductible as an ordinary loss if it was sold at a loss.
The moral of the story is put your property in service. Now.
Tomorrow, I’ll give you the follow-up on this story and how he lost out on an even bigger tax break thanks to the Trump Tax Plan.
If you are a real estate investor, or want to be, I have one big word of caution for you.
Tax planning is hard and it just got a lot harder with the Trump Tax Plan. We can offer you a couple of solutions:
You can have a personal consultation with me. Call Richard at 775-589-2085 for more information on what we do and together you can see if that’s a fit for you.
You can join our coaching program. This is an affordable way to get tax saving, wealth building, asset protecting and cash flow building strategies for both business and real estate. Plus, you’ll get access to me twice monthly. Interested?
Go to https://www.ustaxaid.com/coaching-program/ for more information.