Thanks for asking your question! I'm sorry to hear about your tax issue and I'm going to try my best to help you understand or resolve it.
Thank you for your question. First, the $50,000 that was put into the building is not immediately deductible. Since it is commercial property, the amount plus the purchase price of the building would be depreciated over 39 years.
The amount would be placed on Schedule E, not Schedule C. It is subject to the passive activity loss rules because the intent is for a tenant to stay longer than 7 days in a building. The exception that you are reading about is for places such as hotels and motels - where people don't intend to stay for a long time.
You couldn't have the exception in 2011 and then change status in 2012. Unfortunately, provided that the client doesn't meat the terms of real estate professional they cannot deduct the entire loss
Here's the wording from the IRS Web site: (CLICK HERE
Exceptions to Rental Definition
There are six exceptions to the definition of rental. Under Reg. § 1.469-1T(e)(3)(ii), six types of activities normally defined as rentals, are treated as non-rental activities, i.e. as businesses, in most cases. As a result, the active participation standard and the $25,000 allowance do not apply. If the activity falls outside the rental definition, it is passive or non-passive based on whether the taxpayer materially participates. Following are the six exceptions:
- The average period of customer use is 7 days or less. For example: condo rentals, short-term use of hotel/motel rooms, and businesses that rent videos/tuxedos/cars/tools, etc.
- The average period of customer use is 30 days or less and significant personal services are provided with the rental. Examples: hotels and motels.
- Extraordinary personal services are provided with the rental. Examples: hospitals, nursing homes and boarding schools.
- The rental is incidental to a non-rental activity.
- The taxpayer customarily makes the rental property available during defined business hours for nonexclusive use by various customers. Example: golf courses, health clubs and spas.
- The taxpayer provides the property for use in a non-rental activity of his own partnership, S Corporation, or joint venture. The key word here is “provides,” not “rents.” For example: a partner contributes property in exchange for an ownership interest. This non-leasing transaction with the partnership is not a rental. Reg. § 1.469-1T(e)(3)(vii) states: “Thus, if a partner contributes the use of property to a partnership, none of the partner’s distributive share of partnership income is income from a rental activity…”
So, unfortunately, the passive activity loss applies, and in any event the full $50K would not be deductible in the current year as it would be added to the property's depreciable basis. ** Please take a moment to rate my response as "Excellent" so that I may be compensated for assisting you today. Please let me know if my assistance was anything less than "OK Service", as I am compensated based on whether or not I have assisted you with your issue. If you need further clarifications, PLEASE WAIT TO XXXXX ANSWER UNTIL AFTER RECEIVING FOLLOW UP FROM ME. If I receive anything less than OK Service, I do not get paid, but the Web site will still collect your payment. Thank you for your kind understanding in this matter. If you have difficulties rating, then simply respond stating that you are having difficulties rating and thank me for my excellent, good, or ok service and we can get the rating applied by the site**