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Capital Gains Tax on Rental Property
Rental Property Tax Deductions
Depreciation of Rental Property
Mixed-Use Residential Property
- Common Areas
- Renter or Girlfriend?
- Tenants in House
- Too Much to Gain
- Converted Rental
- Alaskan Chill
- Vacation Rental
IRS Forms
Mixed-Use Residential Rental Property
How to Report Income, Expenses, Profit and Loss If You Rent Out A Portion of the Property That You Live In
The Basic Rules:
Common Areas
Dear TaxMama:
I checked out your FAQ, but i didn't see anything that addresses my question, so here it goes.
A home is being partially rented out. That is, the tenant is using the basement (and some common area). After reading the instructions for Schedule E, it seems that the square footage of the home must be identified. Then the tenant's occupied portion needs to be identifed, too, to figure the business portion of the expenses.
What about the common area like the kitchen? Do I figure that if he's using it half the time, that I can use half the size of the kitchen to include in the allocation?
Once the allocation is calculated, it seems I apply it to the home owners insurance and utilities. Since the mortgage interest and property taxes have already been deducted, they would not be used on the Schedule E, I believe.
Lastly, I guess the original cost of the home needs to be identified to calculate depreciation? I guess we can add in some of the settlement costs and any subsequent improvements, right?
Thanks for bearing up under a very long-winded question.
Tom
••• Tax Mama Replies •••
Hi Tom,
OK, you've got the general concept. The IRS might object to using portions of common areas, but you could probably convince them.
Don't forget to add the square footage of the garage to the house. And take into account the square footage he uses for his car and storage.
You can allocate the insurance, utilities, cable tv - if he uses it, gardener, housecleaner - if you have one.
As to the mortgage and property taxes - allocate the appropriate percentage to Schedule E also. You'll be reducing the deduction on Schedule A, accordingly.
On the cost of the home - look at your original purchase documents. These are the things you don't include in your cost: property tax proration, points pre-paid insurance of some kind (home repair policy) funds going into an impound account (property taxes, insurance)
Add up everything else.
From this, you'll need to deduct the value of the land. See if you can find your appraisal report.
Worst case, if you have absolutely nothing else to go on, use your property tax assessor's statement. It usually shows the land and building value. Ignore the numbers on the statement - but do use the percentages. (e.g. the statement shows land worth $100,000 and improvements worth $125,000, total property worth $225,000. So your building value is 125/225 = 55.55%)
Whew, I'd better go answer someone else's questions while I still have the energy!
Renter or Girlfriend?
Dear Tax Mama,
My boyfriend and I live in a house he purchased in May of this year. The house and the loan are in his name alone. I pay him a monthly amount equal to ½ the mortgage. We are currently in the process of extensive renovations for this house as well.
The house is his primary residence, but is it also a rental property because of the money I pay him.
1. Is there a tax benefit to claiming me as a renter? and
2. Can he deduct improvement costs (like you would on a regular rental property) and/or ½ the utilities if I am considered a renter?
3. Does he have to claim the money I pay as income, if it is used to pay the mortgage?
Detail you may need to answer this: His income is approx. $100,000/year and my income is approx. $40,000/year.
On a side note, I read your article "Why Congress wants you to live in sin" and I couldn't agree more. We would like to get married, but we figured out it could cost us in excess of $5,000/year in taxes to do so! As a young couple paying for a house, 2 cars, and saving for retirement (since we don't expect Social Security to be there when we retire in 40 years) a $5,000 penalty is a BIG deterrent to getting married.
Thanks in advance!
Gwen
••• Tax Mama Replies •••
Hi Gwen,
Looks to me like your boyfriend could get more benefit from using the full deduction for the mortgage than if you were to share title and split it.
However, you COULD both be on title and on the loan, if you wanted to build up credit and equity.
HE could still take the deduction, if he makes the payments.
I'm not sure why you're paying 'rent' at all. Perhaps you are paying the utilities and groceries, as your share of the household expenses?
The two problems with dealing with rental income and treating half the house as rental property are - when it comes time to sell the house:
1. half the profits will immediately be taxable
2. The $250,000 personal residence exclusion will not apply to the business half of the house
Actually, there is a third problem:
3. You will have depreciated the value of the building and improvements, so the profit on the business half will be that much higher.
If you plan to sell the house in the next 5 years...maybe it should not be a rental.
Do a recalculation of the taxes if you file jointly. With there being such a big difference in your incomes, are you sure there is still a big penalty? ( I wouldn't do it if it cost me $5K either.)
On the other hand, if he did treat you as a tenant, he would claim your rent as income, depreciate half the house (Building value only) over 27.5 years. He would be able to take a depreciation deduction for half the improvements, over 27.5 years. He would be able to deduct half the utilities, the gardener, any housekeeping, maintenance, etc.
Some reasons why this might work well (if you don't plan to sell the house anytime soon)?
1. This would reduce his Adjusted Gross Income (AGI, total on page 1 of the Form 1040.)
2. That increases the amount of medical expenses and employee business expenses he could deduct.
3. If his itemized deductions would otherwise be high, moving half the mortgage and property taxes to Schedule E could protect him from (or reduce) any surprise Alternative Minimum Tax. (Form 6251)
4. If his income is just on the border of being able to qualify for a Roth IRA, reducing the AGI might make him eligible.
There may be some other benefits...
If you are operating any kind of business at home, you could get away with taking a rental deduction on your tax return, without worrying about getting him into trouble.
Take some time and test out the different alternatives and see which one produces the best final tax results.
Tenants in House
I Am Renting Two Rooms from Our 4 Bd Home to Foreign Students ... Do We Need to Declare this Income as Rental Income???
Please Help!!
Thank You
Jim
••• Tax Mama Replies •••
Dear Jim,
If you're asking, you already know the answer. YES.
Report the income on Schedule E. And use Form 4562 to report the depreciation.
Remember to take the appropriate percentage of the homeowners' insurance, utilities, maintenance (pool, garden, janitorial) and repairs.
If their rent includes room and board, include their share of the cost of food - and keep receipts to back it up.
By the time you get done, not only will you not have paid tax on the income, you'll probably have a small loss.
Too Much to Gain
Aloha TaxMama,
Glad I found you. Ok, here's the problem.
My parents have 3 houses on two adjacent lots. The first house and first lot has been rental property for over 20 years. The second and third house are on the second adjacent lot. The second house has been rented for the past 15 years, and the third house has been the residence of my parents for about 15 years.
My parents have decided that the headaches of being a landlord for the two houses are too much to bear, and have decided to sell both properties, find a house to rent for themselves, and use the money they receive from the sale of the two properties as a nest egg to supplement their retirement pension income.
I told them that because the houses are so old, the cost base is low and their capital gains tax will be very high.
What do you suggest they do to keep their tax bill at a minimum? Keep in mind that my parents are in their eighties, and want to move to someplace closer to hospitals, shopping centers, etc.
Mahalo (Thank you)
Kona
••• Tax Mama Replies •••
Aloha Kona,
If I were in that position at that, this is what I would do:
1. I would sell the personal residence. Because with both people alive, the capital gains exclusion on the residence is $500,000 - so, no taxes.
2. I would move into one of the rental houses and turn it into a personal residence for two more years. The money you make from the sale of the first house will more than pay for transportation to hospitals, shopping centers, etc. At the end of two years, it could be sold, with the same $500,000 exclusion. (As I understand it, a decedent's estate can still take the exclusion for the decedent's half of the house, in case one of your parents, heaven forbid, dies during that time.)
3. I would take the third house and exchange it for rental property someplace I'd like to live 2 years from now. And either have my children manage it or hire a management company. In two years, I could move in and convert that to personal residence ... and repeat the process.
In the meantime, should either one or both of your parents die during this time - the properties they still own would get an automatic increase in tax value to their fair market value at date of death. That means, their heirs could sell them with no income tax consequences.
However, depending on how much they are worth, you might have some estate tax consequences. So, please, sit down with someone and do some planning.
Converted Rental
Dear TaxMama:
I bought a condo 16 years ago, lived in it myself for 3 years, then moved away and rented it out for 12 years, deducting depreciation as an expense the whole time.
I moved back last year and am living in my condo again. I think I read somewhere that selling a former rental property, for which depreciation was deducted, within 2 years after taking it out of rental status, triggers some sort of taxable event related to the depreciation previously deducted.
Any truth to this?
What would be the IRS Code section that covers this?
Thanks much!
Gloria
••• Tax Mama Replies •••
Dear Gloria,
Have you ever noticed that life is infinitely more complicated than the tax code?
First of all, just by living in (without selling the property) you don't trigger anything.
Second, the two years figure that you've heard, relates to qualifying you for the special tax benefits that come from selling your personal residence.
If you live in the house as your principal residence, for two years out of the last 5 years, when you sell it, you don't have to pay taxes on the first $250,000 of profit ($500,000 if you're married).
However, you're right, if the house was rental property, you do have some issues with recapturing the depreciation deductions. Or reducing the tax cost (basis) of your home for the depreciation that has been taken.
There may also be some issues with a percentage of the home being treated as business, depending on when you sell.
BEFORE you sell your home, please sit down with a local tax professional who is familiar with mixed use property and ask them to let you know what your tax consequences will be.
Today TaxMama hears from Doug in Alaska who has this tale of woe.
“We have an apartment downstairs, that my wife and I have rented for the last three years. We decided that rather than put my ailing father-in-law into assisted living we could set him up in our unit below, where hospice and other available medical help could assist.
Since there was no income from the apartment, we are no longer able to depreciate the appliances we’d originally installed. There’s no income to offset the heating costs or electricity. As you know oil, heat and the cold here in Alaska can put a big dent in a fixed retirement budget.
••• Tax Mama Replies •••
Hi Doug,
Here are some thoughts – and you can see if they work for you.
Consider having Dad pay rent on the apartment. You can charge him about 2/3 of the regular rent you would charge a stranger, and still not incur the wrath of IRS. And you can use the money he pays you to cover Dad’s costs. It’s just moving the money from one pocket to the other.
But this should enable you to depreciate everything, and write off the property taxes, interest, utilities etc. You’re still likely to have a net loss, even after picking up the rent as income.
On the other hand, you can deduct the property taxes and interest as a second home, and stop treating it as a rental altogether.
You won’t get to deduct the utilities, but…at least you get some tax benefits.
It’s nice you two are being so good to him. It’s so miserable being in a hospital these days!
Vacation Rental
Dear TaxMama:
I have heard that if one owns a vacation/second home, there is an IRS ruling that allows the owner to rent the home for a short period of time, such as one or two weeks and have the income legally unreported.
Can you tell me if this is still the case and where one can find more information on the tax rules?
Thanks Mamma,
James
••• Tax Mama Replies •••
Hi James,
Actually, that IRS code allows you to rent your own home, not just your vacation home, for 14 days or less, tax-free. Isn't that a kick?
During the Los Angeles Olympics, I helped a friend build a whole business around it. Over the next 10 years, until he died, he generated thousands of dollars of free income, each year for several hundred homeowners in Southern California.
IRS Publication 527 has more information about renting out your home or vacation home and how to compute percentages of time and all that.
It also contains this little passage:
"Rental of property also used as a home. If you rent property that you also use as your home and you rent it fewer than 15 days during the tax year, do not include the rent you receive in your income and do not deduct rental expenses. However, you can deduct on Schedule A (Form 1040) the interest, taxes, and casualty and theft losses that are allowed for nonrental property. See Personal Use of Dwelling Unit (Including Vacation Home), later."
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