Business & farm

So, let me talk about capitalization for a minute.

If you owned real estate as an investment, prior to 2018, you could choose to deduct your carrying costs as an itemized miscellaneous deduction subject to the 2% rule, or capitalize your costs (add them to the cost basis). Capitalizing costs required attaching a written statement to your tax return each year that you had costs to capitalize.  (These costs would mainly have been utilities and maintenance, since all your property taxes were already deductible on schedule A.)

You could also deduct (as a misc itemized deduction subject to the 2% rule) the carrying costs for other investments of property (property in this case meaning anything that you can own and hold title to, where "real property" is a specialized term meaning land and anything that is permanently attached to the land).  So you could, for example, deduct the cost of a safe deposit box in which you stored gold coins you bought as investments.  Intellectual property (e.g. domain names) would have been allowable as property.

Now, the first problem is that I don't know for certain that you could elect to capitalize carrying costs on non-real property.  The code just says "property" but the examples given are all for real property.  I think you could capitalize carrying costs on other types of investment property but I am not a tax attorney.

The second problem is that, even if the election is allowed for a domain name, it would have to have been made on every tax return since you bought the property.    And the third problem is that section 266 says you can choose to capitalize costs that would have been deductible; and since the tax reform act eliminated the miscellaneous itemized deduction, the carrying costs aren't deductible.  So section 266 might no longer apply, but the IRS has not issued a ruling.

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Now, separately, if you were reporting your domain name trading as a schedule C business, you should have deducted your carrying costs as business expenses in the year the expense occurred.  (Or you had the option of capitalizing them, but it would almost always have been better to deduct them as business expenses.)  

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So in your example, were you a schedule C business at some point?  And when did you stop filing a schedule C?  Because if you were a schedule C business in 2015, 2016, and so on, you should have already deducted your cost as well as your annual registration fees, and you can't deduct them again.

Then when you stopped being a business and started being a hobby, you would have had to make the written section 266 election on each tax return after that.  You could have made the election for tax years up to 2017, so only your 2018 and 2019 costs would have been lost.  

I don't know if you can file an amended return at this point to make the election for prior years where it would have been definitely allowed (up through 2017).  You can probably amend tax returns that are within the 3 year amending deadline (2017, 2018, 2019), but I don't know if you can amend earlier than that to make the election.  You would make the section 266 election and hope you don't get questioned.  

Or, you could go back to being a business which would allow you to deduct your expenses in the year you paid them.  That might also mean filing extensive amended returns to add a schedule C showing zero income and your carrying costs.  And filing a business for several years with no income might cause the IRS to come back to you and tell you it was a hobby and to do it over.

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In fact, as I review this, your entire $100 cost might be taxable at this point.  We haven't discussed amortization or depreciation; in business, you normally have to depreciate assets over their useful life, and this includes intangible assets, which includes trademarks and domain names. 

Consider the following scenario.  (I assume the useful life to be 5 years on average.)

Bought in 2015 for $10, deducted $1 for depreciation on schedule C, your cost basis is now $9.

Paid $10 fee in 2016, deducted the $10 fee as a business expense and deducted $2 for depreciation on schedule C, your cost basis is now $7.

Paid $10 fee in 2017, deducted the $10 fee as a business expense and deducted $2 for depreciation on schedule C, your cost basis is now $5.

Paid $10 fee in 2018, did not file schedule C, did not elect to capitalize. 

Paid $10 fee in 2019, did not file schedule C, did not elect to capitalize. 

Sold for $100 in 2020.  Since your cost basis is $5, you have a $95 capital gain.  $5 is taxed as depreciation recapture at your ordinary income tax rate (capped at 25%) and the other $90 is taxed as a long-term capital gain.

You have to pay depreciation recapture on depreciation you took or could have taken even if you didn't take it. There is a way to fix the problem of not taking depreciation but it requires an accountant.

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Overall, you may want to pay for professional advice if the amount is substantial.  If the amounts are small, I would assume that you need to pay capital gains tax on the difference between your selling price and the cost basis, and you lose any deduction or adjustment for carrying costs.  If you deducted the purchase price as a business expense on schedule C, then your cost basis is zero and you pay capital gains tax on the entire amount, and call it a learning experience.