How do I treat interest paid on an investment property?

snipped-for-privacy@hotmail.com posted:

Assuming you never "used" this interest as an expense item over the years, the standard method is to add it to the cost basis, when reporting the proceeds from sale on Schedule D. Bill

I disagree. If this was strictly land, it was investment property and any interest paid classified and deducted as such. Interest is only capitalized on property not placed in service, raw land in and of itself never CAN be placed in service.

-- David M. Woods, EA, ChFC, CLU Woods Financial Services Norwood, MA 02062

What about the election available under IRC 266 as more fully explained by Reg. 1.266-1 ??? MTW

I don't have a problem with making the election. I must admit that I am not sure how the election is implemented when it is after the fact. Here's the wording: (3) If the taxpayer elects to capitalize an item or items under this section, such election shall be exercised by filing with the original return for the year for which the election is made a statement indicating the item or items (whether with respect to the same project or to different projects) which the taxpayer elects to treat as chargeable to capital account. Does that mean if I make the election in 2004, the year I sell land purchased 10 years ago, I can accumulate into cost all the property taxes and interest I never expensed? Or does it mean I can only accumulate as part of cost, the 2004 (the year I make the election) taxes and interest? What If I had expensed the taxes and/or interest just once five years ago? What if only took the standard deduction on all tax returns for the last 10 years?

-- Alan

My understanding is that you are supposed to make this election on an ANNUAL basis, and therefore any such election is only good for the particular year in question. However, I would be willing to bet that if you made the election ONCE and thereafter did NOT deduct any such carrying charges, the Tax Court might nevertheless allow the accumulation for the years subsequent to the election (but no guarantees from me on that). The standard deduction situation is a good question, and without research I don't have an answer for that. Mostly, I was simply responding to David's assertion that interest could never be capitalized on land not "placed in service" (if I understood his comment correctly). MTW

Sorry for the delay in responding..... I can't see how you can make annual elections and still conform to the rules regarding a change in method of accounting. It seems to me that if you make the election to capitalize interest expense for an item, you are stuck with it unless you get the IRS's permission to change back to expense.

-- Alan

Reg 1.266-1 clearly defines this as an ANNUAL election. I agree that such a formulation is probably unusual. And, who knows whether the Supreme Court would uphold the Reg...

MTW