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How are Startup Expenses Treated for New Rental Properties

Most real estate investors need to spend some money to get their business started. The costs incurred before they are actually in business are known as start-up expenses. Special tax rules and regulations govern the deductions for a rental property as well as other related costs.

If you are not yet in the real estate business or you are planning to expand your residential rental businesses into new geographic areas, it is essential to know how startup expenses for a rental property are treated. When projecting your taxable income from your current rental property, you should be mindful of the start-up expenses. 

In rental real estate businesses, the costs you incur before your property is ready are considered to be start-up costs and they are not deductible.

What are the Start-up Expenses?

Start-up costs are the expenses you incur to get the rental business up and running. Any expenses that can be deducted as operating costs of the ongoing business are considered to be start-up expenses when they are incurred before your business starts. The common start-up costs for a rental property for real estate investors include incidental or minor repairs, outside office expenses that you pay for before your rental starts, home office expenses, expenses related to real estate seminars and conferences.

Other costs include the expenses of investigating what it takes to create successful rental businesses, property maintenance costs, insurance premiums, and costs for training employees as well as the fee you pay to market research firms and lawyers. Unlike operating costs, start-up expenses cannot be deducted in the same year since the cash you spend to begin a rental business is considered to be a capital expense. Start-up businesses primarily fall into one of three groups:

• Pre-Opening Expenses: The pre-opening costs are what you pay or incur in connection with activities you engage in for-profit generation and production of income prior to the day in which the business begins.

• Investigatory Costs: Investigatory costs are the amounts you pay or incur in connection with investigating the acquisition or creation of a business or trade. 

• Organization/Formation Costs: These are the amounts you pay or incur in creating active businesses or trade. 

How are the Start-up Costs Treated for Tax Purposes?

All costs identified as startup expenses are treated and handled differently for income tax purposes. These costs cannot be deducted in the same year since the costs are deemed to offer benefits over many years. They are handled and treated as capital expenses, and they are deducted equally over fifteen years. 

Currently, there is a provision that allows all taxpayers to deduct approximately $5,000 in the start-up expenses during the first year of an active business with the remaining balance amortized over fifteen years. 

About the Expenses to Obtain a Loan or Mortgage

The costs you incur in connection with getting a mortgage need to be amortized over the entire life of your mortgage. Costs like mortgage commissions, recording fees, and processing fees are amortized and capitalized. The points are the expenses incurred by the borrower to obtain a mortgage or loan. 

Sometimes, these expenses are known as premium charges or loan original fees. Points are primarily prepaid interest; however, they cannot be deducted in full during the payment year. You must amortize your points over your loan’s life for your rental property. 

How to Avoid a Start-Up Rule’s Bite

Start-up tax rules will affect you if you spend over $5,000 first-year set limit before renting your property. All amounts above the set limit will be deducted over fifteen years. This means that you need to stay under the set limit. For you to operate under this limit, you will need to keep careful track of the amount of money you spend. 

In case you go near, or above the set limit, you should cut back on your current spending until the rental business starts. As a real estate investor, there are various expenses you can comfortably put off paying until you are in the rental business. 

However, you should try your best to keep the total start-up costs under $50,000 since your first-year set limit is always reduced by the amount you spend over the costs on start-up expenses. 

When is Your Property Considered Ready for Rent?

Currently, there is confusion about when your property is ready for rent. It is essential to consider and establish this point in time since subsequent expenses aren’t treated as the start-up expenses needing capitalization. All rental activities start when your property is ready for rent and not when rented.

The costs for a rental property you incur when your structure is vacant aren’t the start-up expenses since it is available for rent. In case taxpayers incur startup costs, they should be capitalized and separated in accordance with the current International Revenue Code. Contact a qualified CPA for more assistance getting your business started and finding your tax cuts.

About the author

Seattle CPA+John Huddleston has written extensively on tax related subjects of interest to small business owners. He is a graduate of Washington State University and the University of Washington School of Law.