How to report taxes on flip between tax years

Question

Hi - I have a general question on taxes for flips. I purchased a house with a partner in 2017 that we rehabbed and will be selling in 2018. There were a decent amount of costs incurred in FY17, but I'm not sure if these costs are capitalized into the property and then offset the gain upon sale or expense as incurred. My partner met with a tax professional who said we shouldn't be expensing anything in FY17, but this seems strange to me for items like mileage and other operating costs. What do you think?

Also, does anybody know a good real estate tax professional who has the capacity to take on another client this late in the game? I know it's ironic that I am a CPA in public accounting...but I don't do taxes!

Thank you!

Also, does anybody know a good real estate tax professional who has the capacity to take on another client this late in the game? I know it's ironic that I am a CPA in public accounting...but I don't do taxes!

Thank you!

Rochelle Ray · Answer

Thank you @Alan Rohrer.  It is a fix and flip. Thank you. That clarified a lot for me.  I appreciate your help and prompt reply.  Sorry for the confusion on thinking you did not handle taxes.  I don't feel so overwhelmed now.

Alan Rohrer · Answer

@Rochelle Ray

I actually do work with taxes! (prep, planning, etc.) I was just saying in my post above that it's important that your accountant does taxes...PLUS be an advisor (which is where accountants bring the most value).

To answer your question:

I am assuming you are talking about a fix & flip, rather than a buy/hold.

This will not go on Schedule D because you aren't selling an investment with capital gains/losses - you are selling a piece of inventory so there are no capital gains. When I say "capitalize", think of it as just increasing the book value of the inventory... it doesn't have anything to do with an investment asset as the word may make you think.

You will record "cost of goods sold" when you actually sell the property. In 2017, the costs to improve inventory will be added to the cost of the property and expensed as COGS when sold.

Only items that will be expenses in 2017 will be things that don't improve the inventory (like a home office deduction, travel expenses, etc.).

Keep in mind that there may be other facts I'm missing so be sure to talk with your accountant/advisor who has a full picture of your situation.

Rochelle Ray · Answer

@Alan Rohrer, I know your not a tax person but a CPA but maybe you could answer one question that I can't seem to find an answer for and it is driving me insane.  If I haven't sold the property yet, just like Spencer's situation, and I am going to write off the costs in 2018 when it is sold at that time, do I still need to list the items to improve the inventory under Sch C Cost of Goods Sold this year, which is the year of purchase of the items to track inventory or is there no inventory because it is all capitalized under Sch D?

Spencer Wetmore · Answer

@Alan Rohrer

I'm gad you understand my pain! I usually end up just saying I do taxes otherwise they just get really confused and keep asking tax questions anyways.

This response certainly helps and I will see if I can find a real estate specific tax professional. If you know of any in the area, feel free to pass their contact along.

Thank you Alan!

Alan Rohrer · Answer

@Spencer Wetmore

I was in audit as well for my first few years in accounting (but I work in tax now), so I've felt the pain of everyone saying "oh, you're a CPA!? can you answer my tax questions!?", then having to explain to them I really can't!

Hopefully this will clear things up:

You are correct with your understanding that you can't write off any costs related to inventory (the house) - whether that be the cost of the house, or items to improve the inventory (like lumber, paint, contractors, other flipping expenses).

However, if the cost does not relate to the purchase or improvement of inventory (the house), it can be written off as operating costs, as you noted. This would include your mileage, home office deductions (if you have one), advertising you may have done to find the house, etc.

I would make sure you get in contact with a Real Estate savvy CPA (plenty here on BP!), as your instincts to seek a second opinion were spot on.

Many CPAs serve countless industries and can result in them being too overwhelmed/busy to know the nuances of RE.

But congratulations on getting through your first flip! Hope this clears things up a bit.