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E224
Returning Member

Bought a home to flip in 2017. Sold in 2020. Never claimed expenses. Claim all previous year's expenses on this year's return since I sold it in 2020?

A CPA told me to claim all expenses whenever I sold the property. I just want to be sure it's ok to claim expenses from 2017, 2018, 2019 all on this year's return and the best method to do that.
4 Replies
Opus 17
Level 15

Bought a home to flip in 2017. Sold in 2020. Never claimed expenses. Claim all previous year's expenses on this year's return since I sold it in 2020?

No, your CPA screwed up (or you misunderstood their answer about "expenses.")

 

This gets very complicated and I would send you to another professional but you might get as bad advice as the first.  I will explain some things and maybe you will be able to at least recognize when your expert is wrong.

 

First, let's define "expenses" and "improvements".  Any improvements you make to the home are not expenses, they are improvements.  Improvements add value or extend the useful life of the home or one of it's systems (or the real property the home is attached to).  A new roof, carpeting, remodeling, landscaping, are all improvements.   Improvements are never deductible expenses.  Improvements are added to the cost basis of the home and reduce your capital gains.  For example, if you bought the house for $100,000, added $50,000 of improvements, and sell it for $200,000, then your capital gains is $50,000.  There are also certain closing costs that can be added to the cost basis, and you can also include certain costs of selling, like staging and the commission.  It is to your advantage to document your cost basis as thoroughly as possible because you are taxed on your gain and the higher you can get the cost basis, the less your gain will be.

 

"Expenses" are anything else that is not an improvement, such as mortgage interest and property taxes, insurance, utilities, lawn mowing, and repairs.  (Repairs restore the property to as-was condition, and do not materially add value.  Painting a room or changing a leaky faucet is a repair.  However, painting a room as the last step in a remodel would be part of the cost of the improvement.)

 

Next, let's define two ways you might report this income.  For you, "flipping" might be a once in a while thing, or it might be an "ongoing trade or business."  If it were an ongoing trade or business, you can deduct many of your expenses, but you pay an additional 15% self-employment tax on your net profit.  Filing this kind of business is beyond my ability to even comment further so if you want to be in business as a house flipper, you really need good tax help to get started.  And you probably need to amend back to 2017 to add the schedule C to your return.

 

Or, flipping might be occasional or casual or a hobby, and not an ongoing trade.  In this case, you report your capital gains when you sell the home.  You will report your purchase price and adjustments to cost basis and the selling price to determine your capital gain, and that is taxed at 15% or 20%, but always a lower interest rate than income earned from working.

 

The capital gains transaction will account for the cost of your improvements.  (And incidentallyyou only include the costs you actually paid for, you can't include the value of your own labor or other labor that you did not actually pay for.)  But what about the other costs like the mortgage interest, property taxes, utilities and insurance?

 

One answer is that you are allowed to deduct all the property taxes you pay as an itemized deduction on your regular tax return.  You are also allowed to deduct mortgage interest you pay on your main home (where you live) and one second home.  The flip house can be your second home for that purpose unless you had another second home.  So you can deduct your mortgage interest and property taxes on your regular tax return.  But this has to be done in the year the expense was paid (2017 for 2017 interest and taxes, 2018 for 2018, and so on.). If you did not deduct those costs then, you can stack them up now, you would have to amend your prior tax returns to add the mortgage and property taxes.

 

Repairs aren't deductible because repairs are something that everyone has a responsibility to do to maintain their property.  However, I expect most of a flip costs are improvements rather than repairs. 

 

Insurance and utilities simply aren't deductible in this way.

 

However, there is a special and complicated rule that might allow you to recover the utilities and insurance as well.  With investment property, a taxpayer has the option of "capitalizing" their expenses.  That means that, instead of deducting the costs when paid, you can add them to the cost basis, which as I said, would reduce your capital gains.  You could certainly capitalize your mortgage interest and property taxes, if you did not deduct them.  You might be able to capitalize your insurance and utilities as well.  However, to capitalize your costs requires attaching a written statement to your tax return for the year that describes the property and the costs you are capitalizing.  So we are back to amending your past returns.  Also, there is some doubt as to whether it is allowable to capitalize costs after the 2018 tax reform, because of certain language discrepancy that I am not going to take the time to explain.  This is when I tell you to see a professional.

 

So to summarize,

  • If you file as a business, all of your costs are recoverable one way or another, although the methods differ for improvements and other costs, and this is much too complicated for me to get into.
  • If you file this as a hobby, you report your capital gains as the difference between the selling price and your adjusted cost basis.
    1. The cost of improvements is added to the cost basis of the property and reduces your taxable capital gains
    2. Mortgage interest and property taxes could have been deducted on your past returns.  If you did not, you can amend those returns to claim the deductions.  The deadline for amending the 2017 return is April 15, 2021, so don't delay too much.
    3. Mortgage interest, property taxes, insurance, and maybe utilities, could have been capitalized on your 2017 return, and maybe 2018 and 2019, although this is awaiting final IRS decision.  To go back and capitalize your costs would again require amending your tax returns.
    4. Costs can't both be capitalized and deducted.

 

Hope this helps. 

 

Publication 523 lists closing costs that can be included in your basis

https://www.irs.gov/forms-pubs/about-publication-523

*Answers are correct to the best of my ability at the time of posting but do not constitute legal or tax advice.*
Cynthiad66
Employee Tax Expert

Bought a home to flip in 2017. Sold in 2020. Never claimed expenses. Claim all previous year's expenses on this year's return since I sold it in 2020?

Not enough details about your situation to be specific to you.  Is this a one time flip?  Are you in the business of flipping houses?  Are you a Real Estate Professional?  Below are a few scenarios, see if it applies to you.

 

In terms of the flip itself, expenses the investor has like the cost of materials needed for the actual renovation, and the cost of labor on the property can be deducted. If you're a fix and flip investor, and you sell your property in under twelve months, then capital gains tax will apply to the income you make.

 

If you are considered a real estate professional and filing a Schedule C, you can deduct the taxes and insurance. If you are not, you must wait until you sell the property.

 

 

However, if this was purchased as an investment to fix and resell, you add the carrying costs including mortgage interest, property taxes and rehab expenses to the basis of the property. When you sell it, all of these costs (and others from the purchase) become part of the adjusted basis for determining gain or loss on the property. Property taxes are added to the basis and are not deductible on Schedule A since they are considered a business expense, not a personal one, because of the status as an investment property.

 

 You will report the sale under the investment section unless you are considered a real estate professional; if you need directions at that time, please post a new question.  Until the property is sold, you do not report any expenses from the purchase or updates you have completed except as noted above for real estate professionals.

 

Finally,  you will need to determine if you are a real estate investor or a real estate dealer.

 

Generally speaking, real estate investors purchase real estate with the intention of holding their properties and gaining a financial return; real estate dealers buy and sell real estate as part of their everyday business. It all comes down to the intent behind the property purchase. Even if you originally purchased the property to hold, but ended up selling it sooner, it does not mean that you are a dealer.

If you are a real estate investor, then the "flip" will be reported as a sale of an investment asset. To report it on your tax return go to: Federal Taxes - Wages & Income - Stocks, Mutual Funds, Bonds, Other. Tell the program that you did sell investments in 2015 - then that you did not received 1099-B - select "Everything Else" - continue entering the rest of the information. This will generate gain subject to preferential capital gain rates. Or a loss will be limited to $3000 deduction against ordinary income.

 

If you are a real estate dealer, then you will report the "flip" on Schedule C. Sales price will be your gross income (general income in TurboTax) and basis will be your cost of goods sold. This income will be subject not only to income taxes at ordinary income tax rates, but also self-employment taxes. You will also need to upgrade your TurboTax software to Home & Business.

 

E224
Returning Member

Bought a home to flip in 2017. Sold in 2020. Never claimed expenses. Claim all previous year's expenses on this year's return since I sold it in 2020?

 
E224
Returning Member

Bought a home to flip in 2017. Sold in 2020. Never claimed expenses. Claim all previous year's expenses on this year's return since I sold it in 2020?

Thanks for your amazing detailed response. I wasn't expecting that much but certainly appreciate it.  When I mentioned "expenses", I was really referring to items that make up the Cost Basis. I set up the S-Corp to be a real estate investor who flips homes. However, bad contractors lengthened the time to get it done properly. Once the property was sold, that's when I would use all of those items such as points, interest, etc to lessen the capital gain from the sale. This would be filed under the S-corp. 

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