An IRS Hot Button – What Is Really The Cost? Part III

Jim Marshall

(This is the 3rd and final article of this series. Click here to read Part 1 and Part 2.)

By now you are getting the idea that “cost“ may be an elusive animal. Still we have only scratched the surface. Let’s talk about other factors that might affect you in the pocketbook.

While these are not all inclusive, and if you have specific questions please contact me and I will address them privately or in general depending on the issue and your preference.

1. Example: you won a 100 unit apartment project. You know you will have continuing maintenance on the while projects and individual units? How or can you deduct the reserves you set aside to do the work?

2. You have a bankruptcy or other forgiveness of debt. How do you treat the rentals, investment properties, personal properties? In general, you would reduce the basis of the assets in specific order as laid out by the IRS and this would become a reduction in the basis of the “asset” that you also must track.

3. You did a like-kind-exchange, the deferred gain on the old property is a reduction of the new asset’s basis. You also report this on the annual tax returns and track the reduction in basis for tax accounting although my may not treat it the same way for a GAAP reporting. (This kind of items create tax deferred provisions which are not a subject of this discussion.)

4. Some of the other direct influences on basis are items such as casualty losses and insurance reimbursements. Think for a second on the recent London UK fire. Not to diminish the loss of life or casualties, the property insurance coverage, the basis of the property before and after the loss, the recent $13M upgrade what do you report.

You are now ready to sell this property you have held for 5 years. You take into account all of the above items but then you have to report the transaction. You have substantial closing costs to sell the property including brokers, title insurance, compliance issue costs to bring the property to the agreed standard, split or agreed costs to close. Where do you report all this? It depends on where you are reporting the transaction> For example if it is a GAAP reporting for financial statements of a public company you would generally reduce the sales price by these cost to report a net sale and deduct the carrying basis item discussed earlier for GAAP purposes. For tax reporting, these closing costs would be added to the basis and the gross sales price reported as the sales price. This is due to the escrow company/attorney (depending in the state) only reporting the 1st line of what would be the HUD-1, gross sales price.

As I have said in other articles, if you contribute real estate assets to a partnership or LLC, your basis within the entity is the value set by the GP or managing member and affected by potentially all of the items discussed in the prior Parts I and II and above. This may bear no resemblance to your actual cost of the property and you should have a separate tracking to deduct the difference on your personal return or defer these items until the end of the entity.

I hope I have given you some insight into the complexities of the real estate industry. It wasn’t meant to comprehensive but more a primer of some of the issues to consider before you commit to an irreversible course of actions. Again if you have specific question or issues please contact me or you tax professional before the MISTAKE.  It is much easier to fix pre-commitment than post commitment.

Jim Marshall

Jim Marshall brings years of experience in tax and audit in a wide range of public and private companies large, medium and small. His experience includes responsibilities for major land acquisitions and dispositions and their structuring including publicly-held banks, savings and loan associations, mortgage bankers, real estate developers, insurance companies, builders and contractors. In addition to a strong background in all phases of tax and audit, Jim is a proven innovator and solution developer on both traditional and nontraditional alternatives.

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