Real estate start-up costs can be tricky for amateur investors to navigate. In this article, we’ll explore the common mistakes made by these investors, including a lack of understanding of what costs are included in real estate start-up expenses, assuming that the purchase price of a rental property is deductible, and deducting travel and exploration expenses.
Not all costs are considered start-up costs that an investor can elect to deduct or amortize. It’s important to know which costs can be considered start-up costs and which ones must be capitalized and added to the basis of future rentals. Real estate start-up costs must meet two criteria: first, they must be expenses that you could generally deduct if you already had the rental in service; and second, they must be incurred before the property is placed in service.
A rental property is placed in service when it is advertised for rent. If on the day of closing, there are already tenants in the property, the rental is placed into service on that day. Otherwise, it’s placed into service the day a sign is placed in the front yard or when an advertisement is placed on Craigslist. Examples of costs that qualify as real estate start-up costs include analysis or survey of potential markets, advertisements for tenants or mailers to find distressed sellers, fees paid to receive legal, accounting, and other professional services, and travel and exploration costs.
Some costs do not qualify, including deductible interest, taxes, and research or experimental costs. If these costs are incurred before purchasing the rental, they will need to be amortized.
The cost to purchase a property is not considered one of the qualifying real estate start-up costs. When you purchase a rental property, you won’t be granted a big write-off for the purchase price. This is because purchasing a rental property is seen as moving money from pocket A to pocket B. You can think of the new property as a personal “bank” and the money you invested as sitting in that bank’s savings account. Writing off the purchase price of a rental property can lead to a full-blown audit, as well as recognizing the entire sale as income if the property is sold later.
Travel and exploration expenses are non-deductible if they are incurred outside of your tax home and you don’t have a rental property in the general geographic location of where you are traveling to. These expenses won’t qualify as real estate start-up costs, currently deductible expenses, or be added to the basis of your future rental unless the rental is within the same geographic location where you incurred the travel costs. Your “tax home” is the general area in which you live and work.
Many amateur investors make mistakes when it comes to treating expenses properly and tax reporting. It’s crucial to understand the criteria for real estate start-up costs, what is and isn’t deductible, and when to amortize expenses. Working with a CPA Firm can add immense value and prevent audits and legal issues in the future.
If you need any help regarding these issues Corridor Consulting would love to help, please schedule a discovery session here, and we’ll be able to address these issues and much more! We’re looking forward to opening many more doors for you!
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This article is not professional tax or legal advice for your specific circumstances. Consult with your professional adviser to better understand