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Regarding the 'capitalize the mortgage interest'. I was a…

Regarding the 'capitalize the mortgage...
Regarding the 'capitalize the mortgage interest'.
I was a partner in a rehabbing/flipping real estate business. We rehabbed two properties in 2016 and sold them in 2017. According to the first property agreement, we paid rent until our project was sold. The second property, we agreed to pay, on behave of the mortgagor, an amount that would bring the loan current. Then keep her mortgage current while we rehabbed the house. Is there still a need to figure mortgage interest for capitalization purposes? How would I report this to the IRS properly?
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Answered in 16 hours by:
9/13/2017
taxmanrog
taxmanrog, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 1,138
Experience: Licensed CPA, MA, MST with 31 years' experience. Teach Accounting and Tax courses at Masters level.
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Under Internal Revenue Code (IRC) §267A, interest on funds used to improve the property must be capitalized. IRC §167 requires all costs incurred to get a property ready for service (the period ending on the date the property is placed into service) must be capitalized. In your case, that would include the rental payments, the mortgage payments (including the principal, as you did not receive the principal when the loan originated), as well as all the costs of rehab.

Furthermore, a renovation project is generally deemed by the IRS to be a capital improvement and can not be expensed. Instead, it is an adjustment to cost basis and recovered through depreciation only after the property is put in service as a rental. The IRS goes a step further and tells us that repairs needed to make the property ready to rent are also adjustments to basis and not expenses.

The IRS says that all direct costs of the property must be capitalized. Real estate taxes paid, even if no development has taken place (if it is reasonably likely when the taxes are incurred that the property will be subsequently developed) must also be capitalized. Once the rehab period begins, interest expense should be capitalized. At the end of the rehab period, interest would again be deductible. If there is a suspension in the rehab period for 120 consecutive days (without regard to normal delays for weather, etc.), capitalization of interest is not required and interest incurred may be retroactively deducted. Any insurance expense properly allocable to the rehab activity must be capitalized and included in the basis of the asset when rehab is complete.

In short, all expenses related to the rehab are to be capitalized.

I hope this answers your question. If you have any more, please feel free to ask and I will be happy to answer.

Thanks! Have a great week!

Roger

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Customer reply replied 10 months ago
That gave me some great information. With the rehab sell not being in the same year as all the capitalized costs, do I just file 1065 without income and expenses (there aren't any costs outside of what would be capitalized)?

That is correct. IF you have no expenses other than those related to the rehab, then the 1065 would be filed as a zero return.

taxmanrog
taxmanrog, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 1,138
Experience: Licensed CPA, MA, MST with 31 years' experience. Teach Accounting and Tax courses at Masters level.
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Customer reply replied 10 months ago
Thanks again!

No problem! If you ever have any questions in the future, please feel free to ask for me.

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