What Costs Are Deductible Prior to Purchasing My Rental Property?
Starting a business takes time and money, but how do you account for your expenditures when you’re starting a rental property business if you haven’t purchased property yet? Your initial outlays count as start-up costs, and those costs come with special tax rules about if and how they can be deducted.
Start-Up Costs for Real Estate Investors
To get your rental business up and running, you spend money, otherwise known as start-up costs. The IRS requires costs to fall into one of three categories to count as a start-up expense:
Creating a trade or business
These expenditures include market surveys or education costs. Think about real estate seminars or conferences you’ve attended, your mileage from going to look at potential investment properties, or your MLS fees.
Preparing the business to open
Equipment purchases don’t count in this category (those are fixed assets and will be depreciated), but office expenses (or home office expenses), advertising costs, and consulting fees all fall under the preparation classification. If you place an ad for your newly available rental unit, buy a fireproof safe to store your lease documents, or rent an office to work from, those are all start-up costs.
Organization costs
If you set up your business as a partnership or corporation by the end of your first year in business, those costs are deductible. These include fees for business licenses, permits, state incorporation, legal or professional services charges, etc.
Note that legal and other fees paid to purchase your rental property are not start-up expenses. Please see our article on Property Purchases and Closings Statements to record those outlays properly.
Real estate investors can hold property in their own name, as a sole proprietor, LLC, partnership, or corporation. Before you decide what kind of entity your business will be, review our article on the advantages and disadvantages of owning rental property in an LLC and consult with your attorney.
If an ongoing business would deduct something as an operating expense, you can record it as a start-up cost.
Deducting Start-Up Costs
The money you spend to start your real estate business is a capital expenditure because those costs will benefit you for more than one year. That means you can’t treat them like operating expenses and deduct them all in a single year. Usually capital outlays aren’t deductible until you dispose of your business, but the IRS has a special tax rule that allows you to deduct up to $5,000 in start-up expenses and $5,000 in organizational costs the first year you’re in business.
Limits on Start-Up Deductions
If you have more than $5,000 of start-up costs (up to $50,000), you can deduct any remaining start-up costs in equal amounts over the next 15 years. That’s the minimum period for amortization, but you may spread the expenses out over a longer period if you’d like. For more information on start-up deductions and limits, see IRS Publication 535.ation.
Once You’ve Purchased a Rental Property
It’s possible to own a rental property but still be in the start-up phase. If your real estate investment business is within its first year of business and your property is not yet ready to rent out, you may have significant outlays associated with it. If you renovate the property to prepare for renters or you incur maintenance charges for the property before it is put up for rent, those can count as capital improvements, affecting the property basis. Check out our overview of fixed assets and expenses to learn more about capital improvements.
Shifting from Start-Up to Operating Expenses
Establishing the date that your property is ready for rent is very important, because that is when your expenditures switch from start-up costs to operating expenses. Once your property is ready and available for rent, rental activity (i.e., operating expenses) begins. You may not have tenants yet; you can have the certificate of occupancy and advertise for renters while the property is vacant. That still counts as rental activity. Any charges you incur to maintain the property and advertise for tenants during this time count as operating expenses.
Takeaway
If you are considering forming a real estate business, remember to take time for tax planning. Minimizing your start-up costs and keeping them below $5,000 allows you to make the most of the special deduction for real estate investors. When starting your real estate investment business, track your start-up costs. The total spent getting your business up and running determines how those start-up costs should be recorded in your books and how much of a deduction you’ll get for them in your first year. REI Hub’s software has a category dedicated to start-up costs, so tracking your expenditures and maintaining your books have never been easier.
