Can Real Estate Builder Credits be Written Off or claimed as a deduction?

[jvtec87]

Hello,

Earlier this year, I put $9,000 down for a new build home for which I planned to use as a rental property. Unfortunately, the builder did not complete the house by the settlement date and we both terminated the real estate contract. As part of the termination, builder agreed to refund all builder credits (May 2021). So far he has not given my money back even though me and my real estate agent have tried multiple times to contact him.

I ended up buying another home in the area but am short $9,000. Can I write this off in my taxes?

I have documentation to prove the builder breached contract as well as the contract termination. 

[Critter-3]

There is nothing you can do until this has been thru the courts and it has been declared worthless ... the contract must have ways to remediate this situation. 

[Mike9241]

The IRS would deny a loss unless you can prove it's worthless and the only way to prove it's worthless is to sue.

[Opus 17]

There are actually two different ways of handling this issue.  Both of the previous answers assume that you are not a real estate professional, that is, you do not buy and sell real estate as your main job. If you are not a real estate professional and you were buying a property to add to a small portfolio (or even just one rental) that you manage on the side from your main business, then this loss is treated as a “non-business bad debt“. Meaning, it is a bad debt that did not arise from your main business.

A non-business bad debt is a capital loss on schedule D that can be deducted against the rest of your income. The maximum amount you can deduct is up to the amount of your capital gains plus $3000, so if you have no capital gains to report, it might take you up to three years to realize the full benefit of a deductible $9000 loss.

However, to report a non-business bad debt, you must have exhausted all reasonable steps and insured that the debt is worthless. This generally means that you must sue, win, put the debt in collections, and verify that the debtor has no assets to pay you (is bankrupt, etc).  Until you have taken all reasonable steps to make sure that the debt is uncollectible, you can’t take the deduction, and if you do not take all the reasonable steps and just give up, the debt is not deductible.

However, if you are a real estate professional, meaning that buying, selling, and managing real estate is your main business, and you report your business activities on schedule C, then I believe you can deduct the lost deposit as a business expense. If you later recover the deposit, then it would be taxable business income, because it would be a taxable recovery of a previous deduction.

[Anonymous_]

I agree, but it should be clarified that a real estate professional (which is sort of a term of art) does not report on Schedule C unless the individual provides significant services to renters or is a real estate dealer (one who holds real estate for sale to customers in the ordinary course of business as a dealer).

Real estate professionals, typically, continue to report on Schedule E.

See https://www.irs.gov/publications/p925#en_US_2020_publink1000104591

[Opus 17]

@Anonymous_ 

In the case of a taxpayer who is a large landlord and buys and sells many properties, but still reports on schedule E, how is this situation treated? It can’t be a personal or “non-business bad debt” if the bad debt was incurred as part of the landlord’s business activities.  Would it be expensed on schedule E, and if so, where?

[Anonymous_]

I can state that only a real estate dealer and an owner who provides significant services to renters (much like a hotel/resort would to its guests) report on Schedule C.

Even owners of large complexes report on Schedule E unless they are dealers or provide extraordinary services. If a firm charges owners (or a separate entity) management fees, then those fees would be reported on Schedule C (i.e., the firm is in the business of providing a service).

Regardless, there would appear to be no deduction on Schedule E unless the payment had been previously included in income.

[Opus 17]

@Anonymous_ 

What about adding the lost deposit to the cost basis of the subsequent building that was purchased?

[Anonymous_]

I would think there are a couple of issues with adding to the cost basis of the building that was purchased.

For one, expenses (as opposed to improvements and closing costs) typically cannot be added to the basis of property if the expenses are not otherwise deductible. 

Further, and obviously, the deposit was for a different building so adding the deposit to the basis of the current building is a real stretch. 

@jvtec87 may be out of luck unless the lost deposit is the subject of a lawsuit and the builder becomes a judgment debtor.