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Megan C
Megan C, Certified Public Accountant (CPA)
Category: Tax
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Experience:  Licensed CPA, CFE, CMA, CGMA who teaches accounting courses at Master's Level
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My client bought a commercial property in summer of 2011.

Resolved Question:

My client bought a commercial property in summer of 2011. He put $50,000 in to it to get it ready to rent. To this day (2012), it has not been rented. According to the Master Tax Guide, this activity is not considered "rental activity" for passive activity rules, since it meets the exception that the average customer use of the property was less than 7 days in 2011. The Master Tax Guide doesn't elaborate on what it is classified as.

An article I found classified this situation therefore as "business property". But what does that mean? Can I put this on a Schedule C and take a $50,000 loss?

If I classify this as "rental property with active participation", taxpayer gets no deduction because he has more than $150,000 in income. At least for 2011, I don't want this to be passive.
Submitted: 2 years ago.
Category: Tax
Expert:  Megan C replied 2 years ago.
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 to read)

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:

  1. 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.
  2. The average period of customer use is 30 days or less and significant personal services are provided with the rental. Examples: hotels and motels.
  3. Extraordinary personal services are provided with the rental. Examples: hospitals, nursing homes and boarding schools.
  4. The rental is incidental to a non-rental activity.
  5. 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.
  6. 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.

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Megan C, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 15588
Experience: Licensed CPA, CFE, CMA, CGMA who teaches accounting courses at Master's Level
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Expert:  Megan C replied 2 years ago.
Thank you for the positive rating. Please remember me the next time you have a financial question. Simply enter "MyVirtualCPA" in the subject of your question, and it will be routed directly to me. Thank you again for using JustAnswer
Expert:  Megan C replied 2 years ago.
Thank you for the positive rating. Please remember me the next time you have a financial question. Simply enter "MyVirtualCPA" in the subject of your question, and it will be routed directly to me. Thank you again for using JustAnswer

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