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Zhannaxena
Zhannaxena, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 42
Experience:  I am a NYS CPA as well as a CIA, CRMA and Licensed Real Estate Agent.
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I have a spec house for the past 4 years, is the interest paid

Resolved Question:

I have a spec house for the past 4 years, is the interest paid on the loan deductible as a business expense?
Submitted: 2 years ago.
Category: Tax
Expert:  Zhannaxena replied 2 years ago.

Zhannaxena :

Hello, how are you? I will be helping you today.

Zhannaxena :

By "spec house" I assume you mean a house bought for speculation?

Zhannaxena :

Like a rental property?

Customer:

built

Customer:

I am a home builder

Customer:

I built a spec house in 2006 and it did not sell. I have been paying $20,000 interest on it each year.

Zhannaxena :

Hi I am back


 

Zhannaxena :

Oh I see


so not renting or selling it yet


 


 

Zhannaxena :

Who owns the house, you or a corporation?

Customer:

It was in my LLC name until 2011 and we quick deeded it to my wife and myself.

Customer:

It did not sell, we took it off the market in 2011

Zhannaxena :

So are you waiting for a better financial market to sell?

Zhannaxena :

Well, you can deduct it as a business expense - but it must go in one of two places:

Zhannaxena :

Schedule E - rental property

Zhannaxena :

Schedule C - building business

Zhannaxena :

Do you have any income from this building business in 2011 or 2012?

Customer:

no

Customer:

it is a home that was empty

Customer:

where in schedule C should it go?

Zhannaxena :

Line 16b - Interest "Other"

Zhannaxena :

however, I wouldn't want you to put that if there are no other expenses or income

Zhannaxena :

did the building business have any revenue/expenses in these yearss?

Zhannaxena :

this would be a major red glad for the IRS

Customer:

yes there was other expenses

Zhannaxena :

but any other income?

Customer:

yes

Zhannaxena :

ok good, then you can put it there

Customer:

in 2009 the business had income

Zhannaxena :

but not 2010, 2011 and 2012?

Zhannaxena :

have you filed returns for those years?

Customer:

well, I guess I should say that we had income between my wife and myself, the business only had income of profit 2009 and a little in 2010

Customer:

we had income every year, We both have other jobs,

Zhannaxena :

yes I understand

Zhannaxena :

so here is the thing: if you already filed 2009 and 2010, then amending the return to include the income as a business expense would be a major red flag

Zhannaxena :

the IRS would question it and there may be an audit

Zhannaxena :

if you didn't file 2011 and you want to include it there, you could

Zhannaxena :

but likewise, expenses without income is a huge red flag for the IRS

Zhannaxena :

especially if the result is a net loss, which counteracts your other income

Zhannaxena :

in the future years, while you're waiting to sell, have you considered renting it?

Zhannaxena :

if you had rental income, then the interest expense would be more justified

Customer:

ok, so I should not amend the previous returns, can I put it all on 2011?

Customer:

$80,000 in interest paid

Customer:

We make $200,000

Customer:

gross

Zhannaxena :

oh no, no

Zhannaxena :

it must be deducted in the year it was paid

Zhannaxena :

but I am suggesting that you forget about the $20,000 during those years

Zhannaxena :

I am 95% certain the IRS will reject that amendment to your return

Zhannaxena :

I think you can try to take $20,000 in 2011, if you didn't file yet

Zhannaxena :

or $20,000 in 2012, when you file

Zhannaxena :

however, it would be less conspicuous if you put it on Schedule E as rental income, and it would really help if there was a rental revenue

Zhannaxena :

have you tried to rent it before?

Customer:

what if we refiled for those years and put it on the schedule E, We would have rented it but no one could afford this big of a rental in our area

Zhannaxena :

well, like I said, you could do that as well, but it would still raise a red flag because it's an amended return

Zhannaxena :

esp if you amended all years at once

Zhannaxena :

you can try it but you'll get audited

Zhannaxena :

the IRS would want an explanation

Zhannaxena :

you could tell them "it was open for rental but we couldn't find a renter"

Customer:

which is true, we would have done anything

Zhannaxena :

that's ok if the place is open for a few months between renters - but the fact that it's not rented for multiple years

Zhannaxena :

let me research something

Zhannaxena :

give me a minute

Customer:

It's the size of house in the area,

Zhannaxena :



Limits on Rental Losses






If you have a loss from your rental real estate activity, two sets of rules may limit the amount of loss you can deduct. You must consider these rules in the order shown below. Both are discussed in this section.




  1. At-risk rules. These rules are applied first if there is investment in your rental real estate activity for which you are not at risk. This applies only if the real property was placed in service after 1986.




  2. Passive activity limits. Generally, rental real estate activities are considered passive activities and losses are not deductible unless you have income from other passive activities to offset them. However, there are exceptions.



Zhannaxena :

You may be subject to the at-risk rules if you have:





  • A loss from an activity carried on as a trade or business or for the production of income, and




  • Amounts invested in the activity for which you are not fully at risk.




Zhannaxena :

You are not subject to at-risk limits since your full investment is at risk.

Zhannaxena :



Passive Activity Limits






In most cases, all rental real estate activities (except those meeting the exception for real estate professionals , later) are passive activities. For this purpose, a rental activity is an activity from which you receive income mainly for the use of tangible property, rather than for services. For a discussion of activities that are not considered rental activities, see Rental Activities in Publication 925.


Deductions or losses from passive activities are limited. You generally cannot offset income, other than passive income, with losses from passive activities. Nor can you offset taxes on income, other than passive income, with credits resulting from passive activities. Any excess loss or credit is carried forward to the next tax year. Two exceptions to the rules for figuring passive activity limits are discussed on this page.

Zhannaxena :

*** However, you may be subject to passive activity limits.

Zhannaxena :

Since rental is generally a passive activity unless you're a real estate professional, these losses can only offset other passive activity income.

Zhannaxena :

As a resul, you cannot deduct your real estate loss against your ordinary income (like salaries).

Zhannaxena :

So unless there is rental income the best place for it is Schedule C.

Zhannaxena :

But even there, it is risky due to the lack of income

Zhannaxena :

My professional CPA income - do you not deduct it anyway - IRS will reject it on an amendment or a first filing.

Zhannaxena :

It's a shame because the deduction is so large, but I doubt they will allow it.

Zhannaxena :

income = opinion

Customer:

ok, thank you, XXXXX XXXXX I should have been advised differently 4 years ago, I would be rich if I just had filed for bankrupcy!

Zhannaxena :

welcome

Zhannaxena :

I am sorry you didn't get this advice before

Zhannaxena :

I am always sorry to disappoint a client - I'd like to deduct that kind of loss myself!

Zhannaxena :

however, it's not going to work unfortunately

Zhannaxena :

I guess it's never too late to file for bankruptcy

Zhannaxena :

well, good luck to you, I hope you can sell this home eventually

Customer:

ty

Zhannaxena, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 42
Experience: I am a NYS CPA as well as a CIA, CRMA and Licensed Real Estate Agent.
Zhannaxena and 6 other Tax Specialists are ready to help you

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