If you own any vacant land for investment, you might want to make an election under Code Section 266 to capitalize expenses generated from the investment property, instead of deducting them. With the new tax law changes, it may be more beneficial for you to make the election. Read on to learn more about how you can take advantage of the election and how it will affect your 2018 tax return.
What is §266 Election?
Under §266, the IRS allows taxpayers to capitalize taxes and carrying charges that would otherwise be deducted or wasted. If you have costs associated with your investment property, including interest, property taxes, and other carrying charges, such as insurance and maintenance costs, you can elect to capitalize these expenses. However, you cannot elect to capitalize these costs if the property is operating as a business or anything other than investment purposes, such as a parking lot.
Why do we make the election?
Under the new tax law, many taxpayers may find themselves taking the standard deduction versus itemizing on their 2018 tax returns since the standard deduction has almost doubled for married filing joint taxpayers. Even if you are itemizing for 2018, there is a limitation of $10,000 on your state, local and property taxes. You may not receive a tax benefit from deducting the costs associated with the investment property due to the change in tax law; however, you can choose to make the §266 election to add those expenses to the basis of the property. This will result in a smaller capital gain when you sell the property. As a result, it will lower your taxes when the property is sold.
In addition, investment expenses and real estate taxes are alternative minimum tax (AMT) preferences. If you are taking these as itemized deductions, you must add them back to your AMT income. As a result, if you are subject to AMT, it would not be beneficial for you to deduct these expenses, as those costs would be wasted.
Furthermore, all miscellaneous 2% deductions are no longer deductible with the new tax law changes. Taxpayers can no longer deduct the expenses, such as investment expenses and other carrying charges related to the investment property. Therefore, you might want to consider making the §266 election in order to increase your cost basis.
One last advantage is that this election is made on a year-by-year basis. If property taxes provide you with a current year benefit by taking a deduction, you would not be required to capitalize these expenses just because the election was made in the previous year.
If you have any questions or concerns related to these changes or any other tax matters, please do not hesitate to contact your L&B professional at (858) 558-9200. We are more than happy to guide you through the changes.