 Deducting
carrying costs of investment property
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 Dear
Tax Talk,
I bought an investment property to flip for a profit. It will be
a short-term capital gain. Question: Can carrying costs be deducted
from the gain before taxes are applied? (I understand that buying
and selling costs get deducted ... but how about monthly mortgage
interest?) Thanks for your help.
-- VJD
 Dear
VJD,
Carrying costs of property can either be deducted
or, if you elect on your tax return, they can be capitalized to
the cost of the property. Carrying costs generally include taxes
and interest that would otherwise be deductible but which you choose
to capitalize. Capitalization simply involves adding carrying costs
to the cost basis of the property, which would reduce the amount
of your gain.
In an investment property, you would include your
carrying costs as itemized deductions. Since a variety of tax provisions
reduce or eliminate the benefit of these itemized deductions, sometimes
the capitalization election makes the most sense. For example, if
your adjusted gross income exceeds a certain threshold, depending
on your filing status, your itemized deductions are reduced (phased
out) by 3 percent of your excess AGI. Another example would be if
you are in AMT, or alternative minimum tax, taxes paid on the property
would not benefit you taxwise unless they were capitalized costs.
Since gain on the sale of investment property is included
in AGI, you would move your carrying costs to an above-the-line
deduction. This would eliminate any tax disadvantage, especially
when the gain is short-term and taxed at the same rate as other
ordinary income. If the gain were long-term, an ordinary itemized
deduction may be more beneficial, as the gain is taxed at a lower
rate, whereas the itemized deduction comes off income taxed at a
higher rate.
To make a capitalization election, you should attach
a statement to your return that indicates that you are electing
to capitalize carrying costs associated with investment property,
and describe the property, nature of expenditure and amount. The
election is annual, which means you don't have to continue to capitalize
costs for the same property in future years.
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