Deductions and rent/lease of your home

[Osmosis Mom]

Please advise me here. We are considering renting a home while leasing out our house (since the market is so down these days). However, dh is partially self-employed and essentially has a homeoffice so he took a lot of home-office deductions last year. What to do in case we rented/leased? Dh heard something about you being able to get deductions on both the house you live in and rent AND the house you own and lease out.

 

Thanks a bunch.

[LizzyBee]

For the house you own and rent out, your rental income and expenses will be reported on Schedule E of your Form 1040.

 

For the home you are renting, you'll report your home office expenses on Form 8829, which then carries to Schedule C.

[TravelingChris]

:iagree: with this addition. Once you start renting out your home, you have to depreciate your home. This actually gives you a giant amount of deduction (much bigger than when you just own and live in) but you will have to pay capital gains on that portion when you sell. It is very complicated and I would recommend that you seek a professional's advice to fully work out with you the various options before you move ahead. Realize that after two years of not living in that home, you will be completely taxable on all the gain on that house once you sell.

 

We rented while we rented out our house. The first two years we paid very little in income tax. The last year we sold the house (and we did get to claim the 250,000 deduction on gains because we were active duty military stationed abroad), we had to pay tax on the depreciation we claimed and that added to our normal tax bill. The following year, it was back down to normal.

[LizzyBee]

:iagree: with this addition. Once you start renting out your home, you have to depreciate your home.

 

Yes, there is a line for this on Sch E. Your home's "cost basis" is reduced by depreciation allowed or allowable, so if you don't deduct depreciation expense, you'll still have to reduce the basis of the home for purposes of calculating the gain on the eventual sale.

 

Realize that after two years of not living in that home, you will be completely taxable on all the gain on that house once you sell.

 

This is slightly inaccurate. You can exclude up to $250,000 ($500,000 for a married couple) of gain on a home that you owned and lived in 2 years out of the previous 5 years. So you could conceivably be living away from the home for up to 3 years before the exclusion is no longer available. Also, a taxpayer can only exclude gain the sale of a primary residence once every 2 years.

 

...we had to pay tax on the depreciation we claimed and that added to our normal tax bill.

 

This trips up so many people! Even if the gain is excludable because the home was your primary residence, you still have to pay tax on a portion of the gain up to the amount of the depreciation deductions. But if the housing market stinks and you have no gain, you won't have to pay tax related to the depreciation. In other words, the taxable amount is the lesser of the gain or depreciation.

 

In some cases, the rental losses are not tax deductible (for ex. if a couple's Adjusted Gross Income is more than $150,000 and they have no passive income to offset the rental losses), so the losses are carried forward and are available to offset any taxable gain on the sale. But if you do have tax deductible rental losses, be prepared for the tax hit you're likely to take in the year of sale.

[Osmosis Mom]

This is amazing advice and very specific. I'll show it to my smart dh (because to me this might as well be Korean....).

 

Thanks for taking the time to help in this very real matter.

[Kari C in SC]

This trips up so many people! Even if the gain is excludable because the home was your primary residence, you still have to pay tax on a portion of the gain up to the amount of the depreciation deductions. But if the housing market stinks and you have no gain, you won't have to pay tax related to the depreciation. In other words, the taxable amount is the lesser of the gain or depreciation.

 

In some cases, the rental losses are not tax deductible (for ex. if a couple's Adjusted Gross Income is more than $150,000 and they have no passive income to offset the rental losses), so the losses are carried forward and are available to offset any taxable gain on the sale. But if you do have tax deductible rental losses, be prepared for the tax hit you're likely to take in the year of sale.

 

Can I run my scenario by you? We are renting our Florida house out. I had talked to friend that was an accountant and he told me a little about depreciation, etc. I am planning to have somebody do our taxes this year. What I am now worried about is that when we hopefully sell in 2009, we will end up paying a lot of tax because of the depreciation we got. If/when we sell - we should get between $100,000 and $125,000 profit on our house. Are we going to end up owing a lot of tax? We will at most be renting it for 1-2 years. Thanks for any help!

[LizzyBee]

Can I run my scenario by you? We are renting our Florida house out. I had talked to friend that was an accountant and he told me a little about depreciation, etc. I am planning to have somebody do our taxes this year. What I am now worried about is that when we hopefully sell in 2009, we will end up paying a lot of tax because of the depreciation we got. If/when we sell - we should get between $100,000 and $125,000 profit on our house. Are we going to end up owing a lot of tax? We will at most be renting it for 1-2 years. Thanks for any help!

 

Residential real estate is depreciated over 27.5 years. So let's say that your home in Florida had a cost of $250,000, of which $75,000 is allocable to the lot, and you made $10,000 of improvements. Land is not depreciable, so your depreciable basis would be $185,000. Depreciation for two years would be $13,455. So in 2009 you sell your house, and you still meet the 2 of 5 years rule. Your taxable gain would $13,455, and for federal taxes, it would be taxed at a maximum rate of 25%. So if you're in the 15% tax bracket, it would be taxed at 15%, but if you're in the 33% tax bracket, it would be taxed at 25%. Does that help?