Capitalizing costs to real property
Rental property: Can I elect to not deduct annual interest and taxes,
but to add them to the adjusted basis of the rental property when
I sell? Our AGI is over $150,000 and therefore the interest and
taxes would only add to my loss carry forward that I cannot use
to offset ordinary income in the current year.
You're not losing anything by carrying forward your losses every
year until you sell the property. In fact, capitalizing the cost
to the property (i.e., adding it to the adjusted basis of the property)
might lead to higher taxes when you sell.
When your AGI exceeds $150,000, you're not allowed to deduct rental real estate losses in excess of income from rental activities. Instead these losses carry over until a year that you have income from real estate, either net rental income or gains from sales, or if your AGI falls below the threshold. These carryover losses are considered ordinary losses, which reduce income taxed at higher rates.
If you capitalize the cost to rental property, you
lose in a couple of ways. First, if you have a dip in income, you
cannot take advantage of the losses carrying forward from rental
real estate. The capitalized costs instead are only deducted when
you sell that particular property.
Secondly, when you sell a rental property, your ordinary deductions (i.e., the carryover losses) will reduce income taxed at higher rates. If the costs were capitalized, they would reduce the long-term capital gain from the sale of that property, which is taxed at lower rates. The difference in tax rates could be as high as 20 percent, so if you capitalized $10,000 in costs you would lose out on $2,000 in tax savings. Hence, be satisfied carrying over your losses rather than capitalizing these costs.