Dear Tax Talk,
I have invested in improved land on a lake. I get charged a monthly fee by the association, plus I pay some maintenance expenses. Are any of these amounts tax deductible? Or do I add them to the cost of the land?
There is no building on the land, but it is "building ready" -- sewers are in, streets are paved, utilities are installed to the property lines, etc.
What you consider improved is what we consider unimproved and unproductive. Improved in tax terms means that it has a structure on it. Investment property means property you purchased primarily to realize appreciation in value. If you purchased the property because you thought it would be a nice place to build a home and that it makes a good investment, then the Internal Revenue Service may consider it more of a personal asset rather than an investment property. The distinction is that you can deduct expenses related to the land as an investment property that you could not deduct if it is considered personal use property.
The association and maintenance expenses are deductible as investment expenses under Internal Revenue Code Section 212. Investment expenses are miscellaneous itemized deductions. The total of your annual miscellaneous itemized deductions are reduced by 2 percent of your adjusted gross income and are not allowed for the alternative minimum tax, or AMT. Together with the real estate taxes you pay, these expenses are also termed carrying charges.
You can elect to capitalize carrying charges only if they are otherwise deductible. Because the maintenance, association fees and taxes are deductible, you can elect to capitalize them as well. To capitalize means to add them to the cost of the land to be used later in determining your gain or loss on the sale. If you're not receiving any benefit from deducting these charges, then capitalization makes sense. If you don't itemize or if you're under the AMT, then you're not receiving any tax benefit from these charges. In the case of an individual, the election only applies to unimproved real property.
You can elect to capitalize carrying charges separately for each project you have and for each type of carrying charge. For unimproved and unproductive real property, your election is good for only one year. You must decide whether to capitalize carrying charges each year the property remains unimproved and unproductive. To make the election to capitalize a carrying charge, write a statement saying which charges you elect to capitalize. Attach it to your original tax return for the year the election is to be effective.