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Level 3

Expensing an exploratory real estate investment trip

I took a trip to explore a real estate opportunity.  Driving, hotel stay, meals, hired a title company to research a property.  I am wondering how I can expense it?

 

I have 2 real estate properties that are running at a loss.  I file them under Schedule E.  I don't have W-2 income.  I do make some money from Interest and dividends, but my schedule E losses will bring me into the negative.

 

Any ideas?

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Level 15

Expensing an exploratory real estate investment trip

I have 2 real estate properties that are running at a loss.

That's no surprise. In fact, the real surprise would be if you actually had a taxable gain. It is extremely rare for rental property to actually show a taxable gain "on paper" when you file your taxes. Especially if you have a mortgage on the property.

When you add up the deductible items of property taxes, mortgage interest, insurance and the depreciation you are required to take by law, that alone is usually enough to exceed the total rental income for the year. Add to that any other rental expenses allowed and you're practically guaranteed to show a loss on paper. Those losses just continue to increase with each passing year as prior year losses get carried over with each successive year. So the amount of losses carried over continue to grow with each passing year.  The potential tax hit will come in the year you sell or otherwise dispose of one or more rental properties.

When you sell a property that's when all those losses will actually be realized.  It works like this.

First, all that depreciation you've been required to take by law gets recaptured and taxed in the year you sell. That recaptured depreciation gets taxed at anywhere from 15% to a maximum of 25%. Though if your overall AGI is low enough it's possible to be taxed at 0% (yes, zero percent).

Then your cost basis in the property is reduced by the amount of depreciation taken (or should have taken if you did not depreciate as required by law.)  From that adjusted cost basis your loss or gain on the sale is figured.

 - First, your losses are deducted from any gain realized on the sale of the property. If that gets your taxable gain on the sale to zero and there are still losses left over then;

 - Remaining losses are deducted from other ordinary income (such as W-2 or 1099-MISC income) up to a maximum amount allowed each year (generally, $3,000). If there are still any losses left over to be deducted then;

 - remaining losses are carried forward to the next year where they can be deducted up to the maximum allowed again. This continues year to year until all losses are realized.

So if rental income is your only source of income, it's perfectly possible that with the sale of a rental property, losses could never be used up and at some point in time (such as when you die) those losses would just basically "evaporate" into la-la land, never to be seen again.

But generally when a person sells a rental property, all losses are used up on the gain from the sale leaving some of that gain taxable.  But that doesn't happen often enough to call it "common" or not enough to call it "rare".

Now with only two rental properties, I don't see how it's possible for you to qualify as a real estate professional under the IRS guidelines unless you are also a realtor that deals in the sale/purchase of other properties, like a real estate agency does. That "750 hours a year/15 hours a week" requirement pretty much kills that possibility. 

I have three rental properties myself and there is no possible way on this green earth that I can even come anywhere close to 750 hours a year/15 hours a week managing my three properties. Even if I had all three properties go vacant in the same tax year and did the turn around work myself (which is what I actually do) I would be hard pressed to justify 100 hours on all three properties combined for the entire tax year.  So if I was to claim I qualified as an RE Pro and later got audited on it, there's no question I would lose.

Now with all that said, your exploratory trips are not a valid expense in any way for tax purposes if the trip did not result in the acquisition of a rental property. As far as the IRS would be concerned, you're trying to deduct the cost of a vacation; and they'll pounce all over you for that.

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9 Replies
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Level 9

Expensing an exploratory real estate investment trip

Travel/research expenses as described would be added to the Basis of property(s) purchased as a result. You can't 'expense', as you don't regularly trade in buying and selling properties. Keep details (who/when/why etc) ...

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Level 15

Expensing an exploratory real estate investment trip

the first thing that must be determined is are you a real estate professional under IRC section 469(c)(7)(B)

Qualifications. You qualified as a real estate professional for the year if you met both of the following requirements.
• More than half of the personal services you performed in all trades or businesses during the tax year were performed in real property trades or businesses in which you materially participated.
• You performed more than 750 hours of services during the tax year in real property trades or businesses in which you materially participated.

If you file a joint return, don’t count your spouse's personal services to determine whether you met the preceding requirements.


the hour requirements are per property unless an election is made with the taxpayer's return under 469(c)(7)(A) to aggregate the properties.   changes in the tax rules may allow filing a late election.  seek professional help if you go this route

 

 

if you are not a REP and did not acquire the property, then then the expenses you incurred would be investment expenses which are no longer deductible starting in 2018.  if you are a REP, but didn't acquire the properties , such expense would be considered those  related to fruitless searches for new ventures and would be deductible under IRC section 165 on schedule C.  if you did acquire the property, these would be start-up expenses under  IRC section 195 REP or not. 

 

 https://www.law.cornell.edu/uscode/text/26/195

 

 

 

note that record keeping for the hours spent in real estate activities is crucial.  the IRS has been challenging those that classify themselves as REP's.  The IRS and courts have disallowed the classification where the record keeping was poor.  

Highlighted
Level 15

Expensing an exploratory real estate investment trip

I have 2 real estate properties that are running at a loss.

That's no surprise. In fact, the real surprise would be if you actually had a taxable gain. It is extremely rare for rental property to actually show a taxable gain "on paper" when you file your taxes. Especially if you have a mortgage on the property.

When you add up the deductible items of property taxes, mortgage interest, insurance and the depreciation you are required to take by law, that alone is usually enough to exceed the total rental income for the year. Add to that any other rental expenses allowed and you're practically guaranteed to show a loss on paper. Those losses just continue to increase with each passing year as prior year losses get carried over with each successive year. So the amount of losses carried over continue to grow with each passing year.  The potential tax hit will come in the year you sell or otherwise dispose of one or more rental properties.

When you sell a property that's when all those losses will actually be realized.  It works like this.

First, all that depreciation you've been required to take by law gets recaptured and taxed in the year you sell. That recaptured depreciation gets taxed at anywhere from 15% to a maximum of 25%. Though if your overall AGI is low enough it's possible to be taxed at 0% (yes, zero percent).

Then your cost basis in the property is reduced by the amount of depreciation taken (or should have taken if you did not depreciate as required by law.)  From that adjusted cost basis your loss or gain on the sale is figured.

 - First, your losses are deducted from any gain realized on the sale of the property. If that gets your taxable gain on the sale to zero and there are still losses left over then;

 - Remaining losses are deducted from other ordinary income (such as W-2 or 1099-MISC income) up to a maximum amount allowed each year (generally, $3,000). If there are still any losses left over to be deducted then;

 - remaining losses are carried forward to the next year where they can be deducted up to the maximum allowed again. This continues year to year until all losses are realized.

So if rental income is your only source of income, it's perfectly possible that with the sale of a rental property, losses could never be used up and at some point in time (such as when you die) those losses would just basically "evaporate" into la-la land, never to be seen again.

But generally when a person sells a rental property, all losses are used up on the gain from the sale leaving some of that gain taxable.  But that doesn't happen often enough to call it "common" or not enough to call it "rare".

Now with only two rental properties, I don't see how it's possible for you to qualify as a real estate professional under the IRS guidelines unless you are also a realtor that deals in the sale/purchase of other properties, like a real estate agency does. That "750 hours a year/15 hours a week" requirement pretty much kills that possibility. 

I have three rental properties myself and there is no possible way on this green earth that I can even come anywhere close to 750 hours a year/15 hours a week managing my three properties. Even if I had all three properties go vacant in the same tax year and did the turn around work myself (which is what I actually do) I would be hard pressed to justify 100 hours on all three properties combined for the entire tax year.  So if I was to claim I qualified as an RE Pro and later got audited on it, there's no question I would lose.

Now with all that said, your exploratory trips are not a valid expense in any way for tax purposes if the trip did not result in the acquisition of a rental property. As far as the IRS would be concerned, you're trying to deduct the cost of a vacation; and they'll pounce all over you for that.

View solution in original post

Highlighted
Level 3

Expensing an exploratory real estate investment trip

@Carl great answer.... you actually answered a few questions I was going to ask about how RE losses get carried forward.

 

Good advise - I'll pass on trying to deduct my exploratory trip.  

 

I do believe I qualify as a real estate professional b/c I am the contractor who is DIY'ing my rental properties.  I'm easily putting in 35+ hours a week.  From what I read in an IRS Publication, contractors / Rehaber's count as R/E professionals.  I don't think it matters in this case b/c I'm not going to deduct the exploratory trip which could easily be misconstrued as a vacation.

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Level 3

Expensing an exploratory real estate investment trip

What IRS form do real estate losses get carried forward onto?

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Level 15

Expensing an exploratory real estate investment trip


@wrangler18 wrote:

What IRS form do real estate losses get carried forward onto?


If the losses are passive losses (PALs) subject to limitations, then they are entered on Form 8582.

 

See https://www.irs.gov/instructions/i8582#idm140631061146064

 

If you qualify as a Real Estate Professional and you materially participate in your rental properties, then losses are not passive and can be deducted from other (nonpassive) income.

 

See (for reference) https://www.thetaxadviser.com/issues/2014/jul/skarbnik-july2014.html

Highlighted
Level 15

Expensing an exploratory real estate investment trip

Can you clarify a few things for me please? I believe there may be a way.

I do believe I qualify as a real estate professional b/c I am the contractor who is DIY'ing my rental properties.

Are you a licensed contractor? Do you have ownership in the business? What type of business is it? I've attached a word document that list the 7 basic business types. Please read through it and let me know what type your business is. With that information, I can better tailor my response to your specific situation so I don't cause "information overload" with items that just flat out don't apply to you. I'm hoping your trip may be deductible after all - just not on the SCH E. WHere you claim it depends on the type of business. Additionally, depending on the type of business, there are other things that may be deductible. (or not!)

 

 

 

Highlighted
Level 3

Expensing an exploratory real estate investment trip

Hi Carl,

 

I've been going through some of my older posts on this forum to refresh myself on how taxes for landlords work.  My original post was regarding deducting expenses associated with a trip - I decided to NOT expense it as it may be more hassle/risk than it's worth.

 

But you asked some questions that I must have forgotten to answer.  Questions that could give me clarity on whether the IRS considers me a Real Estate professional or not.

 

I am not a licensed contractor.  Basically I own rental properties and gut renovate them myself.  I do hire laborers to help with maybe 15% of the actual physical work.  I spend 100% of my working time on this endeavor.  And I spend over 1700 hours a year working my real estate business in some form or other. 90% of that work is renovating the place.  I do plan on logging my daily activities in a journal-app because it sounds like something the IRS is looking for.

 

I own the properties.  I don't have a business entity.  And because I do not pay myself, I don't have w2 income or schedule C income.  Elsewhere on this forum someone astutely pointed out paying myself as a contractor would incur Self employment taxes in addition to Federal and state taxes.

 

I suppose I am running a sole proprietorship.  I do plan on forming an LLC in the near future.

 

LMK if this answers your questions.

Highlighted
Expert Alumni

Expensing an exploratory real estate investment trip

You would be considered a sole-proprietor because of the amount of time and physical effort you invest in your business. Investment and rental activities are passive in nature, so that is why they are exempted from self-employment (social security) taxes.

 

As a sole-proprietor, you will pay in self-employment tax as part of your reporting of business income and expenses on schedule C, which will be included with your form 1040 federal income tax filing. 

 

 

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