Question

Facts and Issue: Mary Albers purchased an office building in Orlando, FL on September 15, 2021, for $600,000. According to the appraisal she received in connection with the purchase (paid for by seller), the FMV of the land was $100,000 and the FMV of the building was $500,000. In connection with the purchase, Mary put down $150,000 cash and obtained a $450,000, 20 year, 4.5% loan, paying one point, $4,500, as a loan origination fee. Mary also paid $3,000 for title insurance, $2,500 documentary stamp tax on the mortgage, $50 for a credit report (required by lender), $450 for inspection fees required by lender (termites, roof), $1,500 for one year's premiums on a property insurance policy (covers fire and storm damage, etc.), and $425 for a land survey (required by lender). In addition, she paid at closing $777 representing interest for two weeks in September ($450,000 X 0.045 X 14/365), $4,000 into escrow for future property taxes and $450 for future insurance.

The seller paid $8,500 representing his share of the prorated property taxes, $3,000 representing his share of the title insurance, $400 for the appraisal (paid prior to closing) and $3,500 for document stamp tax on the title.


Beginning November 1, Mary will pay $1,687 interest each month (ignore amortization of the loan principal). She will also pay an additional $1,000 each month into an escrow account for property taxes and $125 each month for insurance. The lender paid the 2020 property taxes of $11,350 in November 2021 (and will pay future years taxes as well) and the annual insurance premium of $1,500 will be paid in September 2022 (and future years).

Mary immediately began using the building in her business. She wants to know how each of the above amounts will be treated. Assume Mary is a cash-basis taxpayer.


Required:
1. Determine her basis for the land and building. For each amount included provide a brief summary of the authority regarding such treatment.


2. Explain the treatment of any amount not included in the basis of the property. That is, identify amounts that are currently deductible, amounts that are not deductible but are included in the basis of the property, and amounts that are accorded other treatment (e.g., they are amortized). Again provide a very brief summary of the authority supporting such treatment.


3.Specifically identify and summarize the total amount deductible (related to this building) by Mary in 2021 (including depreciation, amortization, interest, etc...)

Answer 1

Mary Albers' basis in the land is $100,000 and her basis in the building is $505,375, which includes the purchase price and additional capitalizable costs. The other expenses she incurred are either deductible in the year paid or not deductible at all. In 2021, Mary can deduct interest, a portion of the points paid, and other specific expenses related to her building.

Step-by-step explanation:

Treatment of Costs for an Office Building Purchase

When evaluating the costs associated with purchasing an office building, it is essential to determine which costs are capitalized into the basis of the property and which costs are eligible for immediate deduction or need to be amortized over time. For Mary Albers' case, her initial basis in the land and building would be the purchase price plus capitalizable costs. The land basis would be the fair market value (FMV) at the time of purchase, which is $100,000. The building basis would be the FMV of the building ($500,000) plus qualifying costs: the loan origination fee (1 point on $450,000, which is $4,500), the survey ($425), and the inspection fees ($450).

Other costs incurred by Mary such as title insurance, documentary stamps, credit report fee, pre-paid insurance, and escrow for property taxes and insurance are not included in the basis of the property. Instead, title insurance, documentary stamps, and credit report fee are considered closing costs and are generally not deductible nor capitalized. Property insurance premiums will be deductible in the period to which they relate, and the escrow payments for property taxes and insurance are also deductible when the actual payments from the escrow are made to the taxing authority or insurance company. Points paid can typically be amortized over the life of the loan. The interest paid is deductible in the year it is paid.

For 2021, Mary's deductible expenses related to the building include the prorated interest ($777) she paid at closing, monthly interest payments starting November 1 ($1,687 per month for November and December), as well as a portion of the points paid (amortized for 2021).

Answer 2

Mary Albers' expenditures on her office building purchase in Orlando, FL, will be treated for tax purposes by capitalizing qualifying expenses into her basis and deducting certain payments like interest. The closing costs capitalized include loan origination fees, while interest and insurance premium payments are deductible.

Step-by-step explanation:

Treatment of Mary Albers' Real Estate Purchases for Tax Purposes

Mary Albers purchased an office building and needs to determine the tax treatment of her various expenditures. The authority for the treatment of these expenses can be found in the Internal Revenue Code (IRC) and guidance from the Internal Revenue Service (IRS). Her basis in the land and building would be their respective fair market values at the time of purchase, plus any capital improvements and certain closing costs.

Expenditures contributing to the basis of the property include the purchase price, loan origination fees (one point), and certain closing costs that are directly related to the acquisition of the property. Costs that are immediately deductible in the year incurred include interest payments and property insurance premiums. Other costs, such as inspection fees, land survey, and prepaid interest, may need to be capitalized and added to the basis or amortized over a period.

Mary’s deductible expenses for 2021 related to the building would include the prepaid interest paid at closing, the monthly interest payments starting November 1, and the portion of the property insurance premium applicable to 2021. The monthly payments into escrow for property taxes and insurance are not immediately deductible but are capitalized and contribute to Mary’s basis in the property.