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Capitalizing Interest?

Posted by taxguru on March 16, 2008


Subject:  Question on Selling Investment Property (Land)

Kerry, in ’07 I sold a vacant lot that I had owned for 2+ years.  Originally, I intended to build on it, but a job took me elsewhere and I sold.  Can I book a deduction for all the mortgage interest paid to date as part of the adjusted cost basis to offset the net proceeds?  This wasn’t clear for me as I read through the IRS documents.




You really should be discussing this kind of thing with your own personal professional tax advisor who can assist you better than I possibly could. You shouldn’t be trying to interpret the tax laws in matters such as this.  That is what tax pros are for.

There are a number of ways in which to handle the interest paid on investment property.  It can be deducted on Schedule A as investment interest via Form 4952.

Another option is to capitalize it as part of the cost of the property and thus later on reduce the capital gain when it is sold.  Here is how this is explained on Page 4-14 of The TaxBook via their WebCD:

Carrying Charges—Election to Capitalize Interest and Taxes

A taxpayer may elect to add real estate taxes and interest to the cost basis of unimproved land rather than claim a current deduction.
Situations where this election might benefit the taxpayer include:

Standard deduction. If a taxpayer claims the standard deduction, the deduction for interest and taxes is lost. The taxpayer will benefit from the election to capitalize the amounts, which will increase the basis of the property.

AMT. If taxes reported on Schedule A would be added back to income as a preference item for AMT, the taxpayer may not realize a benefit from the deduction. In this case the election to capitalize and add the amounts to basis would benefit the taxpayer.

A statement listing the expenses capitalized must be attached to the original return for the year the election is made. The election is made on a year-by-year basis. (Reg. §1.266-1)

This is for background info only and should be applied in your case consistently with your previous years’ tax returns and with the assistance of a professional tax advisor.

It looks like you may have screwed up the treatment of the interest on the earlier tax returns and amended returns may be required.  Again, a professional tax advisor should be used to help you with this.  Don’t compound your mistakes by continuing to try to stumble your own way though the tax maze.

Good luck.

Kerry Kerstetter




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