The Tax Cuts and Jobs Act (TCJA) likely requires that you rethink the tax strategies you were using on your vacant land investments.
And the TCJA changes may be such that you have to rethink vacant land as an investment, at least for the years impacted by the TCJA.
The vacant lot and unproductive land are investments. The TCJA gives you three new and/or altered tax law situations every year from now through 2025 that you need to consider:
1. Capitalize the expenses and add them to the cost of the vacant lot or land.
2. Deduct the interest and taxes as itemized deductions.
3. Say goodbye to those expenses that were deductible as miscellaneous itemized deductions before the TCJA disallowed them for tax years 2018 through 2025.
Interest paid on the vacant lot or unproductive land is either
• deductible as investment interest (limited to investment income), or
• capitalized and added to your cost basis of the vacant lot.
You deduct investment interest as an itemized deduction.
But will you itemize your deductions? The TCJA significantly beefed up the standard deduction amounts. For 2019, the IRS updated your standard deduction amounts for inflation to $12,200 single and $24,400 married filing jointly.
Question: do you itemize deductions?
1. Yes. Then deduct the investment interest as an itemized deduction to get the best tax benefit from the interest expense. Because it’s an ordinary deduction, you get the best treatment even if you have to carry over some of the investment interest to future years.
2. No. Then make the formal tax election to capitalize the interest paid. This adds the interest to your basis and reduces your capital gain at the time of sale. This is not as good as a current-year ordinary deduction, but it certainly beats no deduction at all.
Real Estate Taxes
Real estate taxes on the vacant lot
• are deductible as personal itemized deductions, or
• if elected, are capitalized and added to the cost basis of the vacant lot.
Whoa. Doesn’t the TCJA $10,000 limit on the personal deduction for taxes come into play? No. The vacant land is a tax code Section 212 investment, and the property taxes on such an investment are exempt from the $10,000 limit.
Example. You pay $22,000 in income taxes, $7,000 in property taxes on your personal residence, and $5,000 in property taxes on the vacant land. The $22,000 and $7,000 run into the $10,000 limit. The $5,000 faces no such limit. Thus, your itemized deduction ceiling on property taxes is $15,000 ($10,000 limit plus $5,000 for the vacant land).
Again, as with interest above, answer the question: do you itemize deductions?
1. Yes. Then deduct the property taxes as an itemized deduction to get the tax deduction this year (assuming no big changes in your tax bracket).
2. No. Then make the formal tax election as we explain below to capitalize the real estate taxes paid. This adds the real estate taxes to your basis and reduces your capital gain at the time of sale. And as we said about investment interest, it’s not as good as a current deduction, but it’s infinitely better than no deduction at all.
TCJA Denies Other Carrying Costs
You also had lawn mowing and insurance costs for the vacant lot.
Before the TCJA, you had two choices for your vacant lot lawn mowing and insurance expenses:
1. Deduct the costs as miscellaneous itemized deductions, where they suffered from the 2 percent of adjusted income floor and possible total disallowance by the alternative minimum tax.
2. Capitalize the costs using the tax code Section 266 election.
But today, after the TCJA, you get no benefit from the lawn mowing and insurance costs. For tax years 2018 through 2025, the TCJA disallows all miscellaneous itemized deductions, and that deduction disallowance, in turn, makes it impossible to capitalize the costs under Reg. Section 1.266-1(b)(1) because the costs are no longer “otherwise expressly deductible under the provisions of subtitle A of the Code.”
Here’s another place where tax knowledge pays off. On the vacant lot or unproductive land
• you may elect to capitalize some and not other carrying costs (e.g., capitalize interest but not property taxes), or
• you may make the election to capitalize on a year-by-year basis so you can capitalize this year and not next year.
In conclusion, wow! You get to decide your best tax advantage every year. But if you are going to capitalize costs, you must make the election to capitalize in your tax return for the year elected or your capitalization is not valid.
You have tax decisions to make if you own a vacant lot or unproductive land as an investment. We are here to help you with those decisions. If you have questions, don’t hesitate to contact me by scheduling a call, or by emailing at firstname.lastname@example.org.
We specialize in helping clients clarify their taxes so they keep more of their money. Many small business owners who come to see us in Fort Worth, TX generally do not understand the tax law enough to explain it to a fifth grader.