rental property and taxes

[DaveDr89]

All,

I would appreciate it very much if insight could be offered on the questions below. I will also ask an accountant but want to hear a variety of opinions first.

Suppose one buys a duplex that has two sides that are 1/3 and 2/3 of the total size.

Option A: Live in duplex as primary residence (1/3 side)
- Repairs made on rental size would be tax deductible.
- 2/3 of general house renovations (e.g., roof) would be tax deductible.
- 1/3 of mortgage interest would be tax deductible (?)
- If one's income is over 150K, deductions on renovations can't be claimed until sale of house.

Option B: Have primary residence elsewhere
- all repairs on duplex are tax deductible
- no mortgage interest on duplex is deductible (?)

Assumptions:
- house price 315k, renovations 60k, mortgage interest 1k/month, purchased w/ 4 months left in tax year.


My hunch is that it would be beneficial to claim primary residence elsewhere, do all 60k in renovations during remainder of current tax year. Pro: full 60k in future deductions, and increased rent.
Con: lose 4k in mortgage interest deduction, 4 month cost of primary residence elsewhere (assume minimal), and need to document that primary residence is elsewhere. If one then moves back into duplex in subsequent tax year, does this negate the full 60k deduction? Are there other angles I am missing?


Thanks!!

 

[Biggskip]

Another option you could pursue is to live in the building, except that you rent the space from a company that you own.

It depends on how you want to structure your business. Start a corporation and fund it with enough capital such that it can fund all of the renovations and secure a mortgage to purchase the property it will make the math and the accounting much easier. Now all of the interest and the building repairs are tax deductible. The rental income from both units would need to be claimed as corporate revenue, however.

 

[DaveDr89]

Thanks, that's an interesting suggestion. Could perhaps be the "best of both worlds". Perhaps I could have my rent as $1 also to eliminate the corporate income on that front. In this case the house is already purchased and owned as an individual so it might be tricky to do the switch.

 

[Biggskip]

What do you mean by "tricky to do the switch"?

Also, don't **** with the IRS. Just rent the unit to yourself at a fair market value and pay the taxes on the firm's profit. Keep in mind you pay the taxes on the profit, not the revenue. So if you're duplex brings in $30k per year in rent, from both units, you only pay taxes on that you have left over after you pay the mortgage and what you paid for any capital improvements.

 

[DaveDr89]

RE "tricky", I was wondering about the time sequence of events. Duplex purchased a month ago and some repairs already made. Haven't moved in yet. So by "tricky" I mean the repair expenses will have an overlap between individual and corporate structure, perhaps complicating current taxes and taxes at sale (assuming rollover from individual side if personal income exceeds given limit).

In any event, assuming that there are lots of repairs, it appears that if I live there as my primary residence and don't have your suggested setup, then I lose 1/3 of potential deductions from repairs. It seems that I should try to avoid this scenario unless I am missing something in this assessment?

 

[Biggskip]

Well, you're accountant can figure that out for you, but essentially you are just transitioning from a sole proprietorship to an LLC (or something similar). You could just tell you accountant that you had always intended to rent out both units (to whom is unimportant) and therefore all of the expenses use to improve the entire property would be tax deductible. That said, don't worry so much about the tax bill. Worry more about finding a good tenant the will regularly pay their rent and not **** up your unit in the process.

 

[tj100]

A couple of points:

(1) You don't lose the mortgage interest deduction. You claim the place as your primary residence and take the homeowners mortgage interest deduction, OR you classify it as "available to rent" and the mortgage interest is an expense associated with the property (just like maintenance). It does become an issue if your income is >$100,000, as the maximum tax loss that you can claim declines as your income rises.

(2) Don't forget about depreciation. You're going to generate a ~$5,000+ per year tax loss on depreciation, which will help.

(3) Renovations are not tax deductible. It's a nuanced difference, but repairs are tax deductible, renovations are not. So if you make any improvements, no tax deduction (they do raise your basis for future cap gains). Your new roof is NOT tax deductible (except to the degree that it gets depreciated over 27.5 years). Anything that (1) improves the property; or (2) extends the useful life of the property is not deductible.

I have a couple of rental units of sort of similar value ($300 - 400K) and I try to manage them to be cash-flow neutral on an after-tax basis. With the depreciation factor, I usually show a small tax loss on them each year (with rental income obviously offsetting the expenses). In the long run, I'll end up in a taxable situation, as rents should inflate faster than depreciation (which is fixed by purchase price).