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RD
RD, Certified Public Accountant (CPA)
Category: Tax
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Experience:  CPA, MBA, Over 10 yrs of experience in tax planning and business consulting..
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Do we capitalize or deduct mortgage interest/closing costs

Resolved Question:

We are a new S-Corp. We buy houses, rehab them and then re-sell them. We usually hold the each house about 4 - 5 months while we do the rehab. We were advised to treat the houses as inventory in our QuickBooks file and use the Cost of Goods sold accounts to track expenses for the houses including original purchase price, mortgage interest, subcontractors, materials, utilities etc. The 1098s for the mortgage interest came in our personal names (that is how the loans were taken out). As we prepare our 1120S return this year, do we need to capitalize the mortgage interest for the 4 -5 months that we held the loan or can we deduct it on Schedule A Line 5 "COG - Other Costs". Can we also deduct all closing costs in the same manner, using Schedule A Line 5 - "COG - Other Costs" or do we need to capitalize those as well? If we have to capitalize the closing costs, which ones are deductible and which ones do we capitalize?
Submitted: 7 years ago.
Category: Tax
Expert:  RD replied 7 years ago.

Normally direct costs related to the purchase of the house - such as closing costs will be capitalized with the house. Except the points paid and the pro-rated property taxes amount(which can be expensed)- most of the expenses will be capitalized.

However mortgage interest will be treated as the interest on loan to purchase the inventory and hence, can be expensed.

Let me know if you have any question. Bonus and Feedback will be highly appreciated!!!

 

Please note: This advice is provided with the understanding that all the relevant facts have been provided by you. Any change in facts might affect the advice given and hence may not be relied on in such cases.

RD, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 8784
Experience: CPA, MBA, Over 10 yrs of experience in tax planning and business consulting..
RD and 7 other Tax Specialists are ready to help you
Customer: replied 7 years ago.
Reply to Renu V's Post: Could you explain "pro-rated property taxes"? Also, are ALL closing costs capitalized? If not, which ones are expensed and which ones are capitalized?

Does is matter that we hold the houses for such a short time? Do we still capitalize for the 4 months? Could you give me an example? When would we take the remaining deductions then?

Sorry to be so "confused" but I've read so many IRS booklets that I don't know which way is up anymore!!
Expert:  RD replied 7 years ago.

For federal income tax purposes, the seller is treated as paying the property taxes up to, but not including, the date of sale. You (the buyer) are treated as paying the taxes beginning with the date of sale. You and the seller each are considered to have paid your own share of the taxes, even if one or the other paid the entire amount. So part of this related to your share is the property taxes that is deductible.

Most of the other closing costs except points paid if any will be capitalized.

So say you buy house for $100000 pay $5500 inc closing of which $250 is property taxes and $250 is points paid than

You will record your inventory(house) at 100000+5000 (5500-250-250) and expense $250 as property taxes and $250 as interest.

When you sell the house for $125000(net of closing cost) after 4 months-

Your sales will be $125000

and Cost of goods sold will be $105000

Let me know if you have any question. Bonus and Feedback will be highly appreciated!!!

 

Please note: This advice is provided with the understanding that all the relevant facts have been provided by you. Any change in facts might affect the advice given and hence may not be relied on in such cases.

 

Customer: replied 7 years ago.
Reply to Renu V's Post: Okay, the confusion is lifting!! Wohoo!

Here's the last part of that question that I'm still unclear on: We buy the houses and only hold them for about 4 - 5 months before we sell them. Since we treat the houses as inventory in our COG account, should I claim the expenses (property taxes and mortgage interest) in a different area other than on Schedule A under Cost of Goods?

And, when do we claim the rest of any amount that we capitalized? Wouldn't that also be on this same tax return? Maybe I'm not understanding the whole capitalization concept.

I so sorry to pester you with this "dilemma" and I really do appreciate the answers you've provided so far.
Expert:  RD replied 7 years ago.

The property taxes and mortgage interest can be claimed as separate line items but as part of either the cost of goods sold or Operating expenses.

Regarding the rest of the amount that you capitalize, yes you are right that if you sell it in 4 months times the end result will be the same since it will be reported on the same tax return. It would be more of an issue when you buy in one year and the sale actually takes place in another year.

So it is basically an accounting policy issue. And therefore, if you capitalize it right for each and every property, it will give you the right amount on inventory unsold is any at the end of the year and also the right profit on sale of any particular property.

Let me know if you have any question. Bonus and Feedback will be highly appreciated!!!

 

Please note: This advice is provided with the understanding that all the relevant facts have been provided by you. Any change in facts might affect the advice given and hence may not be relied on in such cases.

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