Purchase of property for rehab and sell

[REFUNDMN]

Client purchased a property in a property on 03/15/2022 to rehab and sell. Last year they spent about $120,000 on materials/supplies, etc.… The question is do I put this on schedule C with PAL (Passive Activity Loss) and wait until the property sells to add the income and other expenses, if not do I wait to use From 4797 and fill in the Gross Sales Price, Cost & Expenses etc? Thanks 

[qbteachmt · Accepted solution]

Improving an asset is not expense. It is part of basis in that asset. If the property was not in use at the time, you have new accrued invested value in that asset, without income or expense from that property. That is, for instance, how a Flipping activity is done.

If this is a rental property they are keeping, then you have to determine if the property was available for rent while also being rehabbed.

Expenses are things not represented in the rehab, such as if they still paid for yard work. Ongoing costs such as this are not part of investment. New windows are not expense; that value still exists, right there in those windows.

It's not Sched C unless your taxpayer client is in the business, such as buys, rehabs and flips, all the time. Even then, it still is not expense if that is part of the invested costs (new basis) in the improvements.

"do I wait to use From 4797 and fill in the Gross Sales Price, Cost & Expenses etc?"

Here is the overview of what typically happens:

You buy property, which is part of basis. You invest further via the improvements. That can cross year ends, so there is nothing to report, yet. Once it is on the market for sale, you have the total invested cost as Basis, you have the expenses of the sale (commission, closing fees, etc) and you have the Sale Price. The math gives you profit/loss.

That is either reported by a business person such as a carpenter might do this in their idle time = income from business operations. The property is their inventory.

A homeowner handyman might buy the house next door to flip, and that is the first and only one or once every 3-4 years = more like an investment, not business income.

Facts will determine what applies.

[REFUNDMN]

This helps thanks

[BobKamman]

It's Sched C if your taxpayer client is in the business, such as buys, rehabs and flips, even if this is the first time.  There's no free "first time around."

[REFUNDMN]

Yes, the client normally purchases homes fixes them up and sells them, this is the 1st time it has passed over into the next year.  So you are saying it should go onto the Schedule C with a Passive Activity Loss carryforward?

[BobKamman]

No profit or loss until the deal is completed.  Money spent in 2022 is just added to inventory until it becomes part of cost of goods sold. Schedule C, unless using a corporation or LLC electing to be taxed that way.  

[ljr]

The flip would be shown on a schedule D when it is sold. The rehab costs are not expensed. They add to the basis for figuring gain or loss on the sale. There is nothing to be reported for the rehab cost until the sale of the renovated property. Which in some cases can be more than a year. 

[sjrcpa]

"the client normally purchases homes fixes them up and sells them,"

This is client's business. It goes on Schedule C, not D.

[qbteachmt]

"So you are saying it should go onto the Schedule C with a Passive Activity Loss carryforward?"

Stop thinking of Expenditure and Expense as synonyms. Expenditure is cash flows, but not also by definition is that an Expense. When you put money into your retirement account, that is not Expense. That is Investment.

There is nothing to report. No gain. No loss. There is no activity until it sells. I pointed out, think of this as inventory. If they want to be able to sell it, they first have to create it. Whatever time that takes and the associated costs are invested costs, in anticipation of the sale. There is no operation, so there is no activity to report. They are busy, but not generating business on that property. A landlord generates business on property. Think of the difference between Taxi and Car Sales.

Only when it sells, is that the conclusion of the process, and now you have all the information needed to report those details. Even if they are working on multiple properties at the same time, all they are doing is sinking costs into each project. The project is an inventory item, and will be available to be sold. Sales date is the reporting event. Until then, it's accumulating invested value into each project.

Remember: Expense and income are matched, in that the expense it takes to generate that income is what is being computed. Until it sells, there is no income, so there is nothing to report about the physical property being computed. That's why it is not expense. Not expense while being worked on and not expense when sold. It is Cost of Goods Sold, not expense.

I teach this. All new windows = improvement to the asset. Snow removal or electricity = expense = Poof! Immediately gone as you spend the money.

Hope that helps.

You might find some mentoring on this.