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George Saenz, the Tax Talk columnistDeducting carrying costs of investment property

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

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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.

To ask a question on Tax Talk, go to the "Ask the Experts" page, and select "taxes" as the topic.'s corrections policy -- Posted: May 16, 2006
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