Tax benefits with real estate

14 Replies

Hey guys, I got married this year and I’m trying to find my first real estate to buy. Because of the amount of standard deductions I will now get, I was thinking that taxes will be better if I get depreciation instead of deduction from the mortgage of the primary home. Does anyone know if you can get depreciation if you do house hacking? Or is the only way I can get depreciation is in a separate home?

I am not a CPA, but I know a few things about taxes.  You cannot depreciate your primary residence. You can deduct mortgage interest and certain home improvements that save energy.  Investment property is depreciated over 27.5 years for the home, 15 years for improvements (fence, in ground pool, landscaping, etc), and 5 years for personal property (stove, refrigerator, dishwasher, etc) You can't depreciate the land value. The trick is to minimize the value of the land and maximize the value of the other categories.  Totaled together to equal the appraised or market value. This depreciation can shield some of  the rental income from taxes.  Talk to your tax preparer about these things. Good luck.

If you're open to it, you could rent out a room in your home. This would open up a lot more tax benefits and also get you extra income and be a great starter to RE investing.

Keep in mind that depreciation is a double edge sword.  Folks selling crappy rentals often tout the "tax advantages" of their bad rentals, claiming the by taking depreciation and ending up with a passive loss you save on taxes. 

On a rental property, both depreciation and interest are deductions against the income.  Its not a choice of one or the other.  The biggest benefit for depreciation is to reduce the tax bill on the rental income.

If you do have a passive loss (negative net income after all deductions including depreciation) you may be able to use that to offset other income.  You can if your passive losses are under $25K and your AGI (as a couple, in your case) is under $100K.  If AGI is over $150K, that $25K "special allowance" limit is zero and you cannot use the passive loss against other income.  Between $100K and $150K the $25K limit phases out by $1 for every $2 of AGI over $100K.

The other edge of depreciation is that it reduces the basis for your property.  That means when you sell the gain is higher.  Further, the gain is divided into two parts and has two different tax rates.  The amount of gain up to the amount of depreciation (taken or allowed, whichever is greater) is subject to a tax on unrecaptured depreciation, currently your ordinary marginal tax rate, but capped at 25%.  The remaining gain is subject to capital gains tax.  Assuming you're held for at least a year, that's 15%.

If you live in part of a multi, you will be able to take depreciation on the part of the property that's rented.  But not on the part you occupy.

The usual rule of thumb for splitting improvements and land is 80% of the purchase as improvements.  A better way is to look at the county assessor data.  They usually split up land and improvements.  Use their numbers to compute the ratio for your property.  Then, as you do certain things, the IRS has different depreciation periods for different things you do.  Its a bit more complex that what @Anthony Dooley  says, but that's on the right track.  Flooring, for example, gets a five year depreciation period.  Though if you actually get five years out of carpets in a rental you should count yourself very lucky.

If you go down this road, you will want to find a real estate knowledgable accountant to help with taxes.  Taxes will no longer be a DIY project.

Thank you for the responses.

@ Anthony Dooley Thank you for your information about the 15 years off for improvements I didn’t know you could depreciate that.

@ Nicole W. What tax benefits would come about from renting out a room? I can understand the shared expenses and income.

@ Joe Holdman It is a good thing to know that rental properties you can use depreciation and interest I thought it was one or the other. In regards to the gain when selling I was planning on to hold the property, but it would be a good thing to keep in mind. I was thinking of getting a multi family home for my primary residence to get the benefit of the percentage of depreciation and having a home that I can put money towards the mortgage.

When renting out a room, at least a portion of your home is now a rental. Therefore, you can write off repairs. You can also use depreciation for that portion/percentage of the house. We've done it since 2009 and enjoy the benefits.

@Nicole W.  So it sounds like you're rental like a multifamily but with a bedroom.  Thank you for the tip.

Originally posted by @Jon Holdman :

Keep in mind that depreciation is a double edge sword.  Folks selling crappy rentals often tout the "tax advantages" of their bad rentals, claiming the by taking depreciation and ending up with a passive loss you save on taxes. 

On a rental property, both depreciation and interest are deductions against the income.  Its not a choice of one or the other.  The biggest benefit for depreciation is to reduce the tax bill on the rental income.

If you do have a passive loss (negative net income after all deductions including depreciation) you may be able to use that to offset other income.  You can if your passive losses are under $25K and your AGI (as a couple, in your case) is under $100K.  If AGI is over $150K, that $25K "special allowance" limit is zero and you cannot use the passive loss against other income.  Between $100K and $150K the $25K limit phases out by $1 for every $2 of AGI over $100K.

The other edge of depreciation is that it reduces the basis for your property.  That means when you sell the gain is higher.  Further, the gain is divided into two parts and has two different tax rates.  The amount of gain up to the amount of depreciation (taken or allowed, whichever is greater) is subject to a tax on unrecaptured depreciation, currently your ordinary marginal tax rate, but capped at 25%.  The remaining gain is subject to capital gains tax.  Assuming you're held for at least a year, that's 15%.

If you live in part of a multi, you will be able to take depreciation on the part of the property that's rented.  But not on the part you occupy.

The usual rule of thumb for splitting improvements and land is 80% of the purchase as improvements.  A better way is to look at the county assessor data.  They usually split up land and improvements.  Use their numbers to compute the ratio for your property.  Then, as you do certain things, the IRS has different depreciation periods for different things you do.  Its a bit more complex that what @Anthony Dooley  says, but that's on the right track.  Flooring, for example, gets a five year depreciation period.  Though if you actually get five years out of carpets in a rental you should count yourself very lucky.

If you go down this road, you will want to find a real estate knowledgable accountant to help with taxes.  Taxes will no longer be a DIY project.

 If it is primary house, when he sells it, he will be able to $250k (500k per couple) tax-free capital gain. Would this still be eligible for house hacking?

@Diana Tian   I have no idea how renting out part of the house and the $250K exclusion work together.

Let's not get confused here.  It is either your primary residence or it is an investment property.  @Kirk Chow, you cannot depreciate your primary residence, so it isn't a choice of deduction vs depreciation.  You can deduct interest from your mortgage of your primary residence.  You can depreciate the building, improvements, and personal property of an investment property.  Each have different rules, which are too complex for this forum, so consult a CPA. 

@Diane Tian, you do not pay capital gains taxes when selling a property that was your primary residence for 2 of the last 5 years.  This does not apply to investment property.  When you sell investment property, you will pay capital ga

ins on profits from the sale.  All of the depreciation that you claimed lowers your basis in the property, which can possibly increase your taxes.  This can all be avoided by using a 1031 exchange, which must be handled by a knowledgeable attorney prior to the sale of the property.

If any of that was not clear, I apologize.

@Anthony Dooley   I think @Diana Tian is asking about how to handle a situation where rooms are being rented. I believe that results in the ability to take some depreciation, for the part of the house that's being used as rentals (which seems to be called "house hacking", my great grandma called it "taking in a border"). IDK if that means the $250K exclusion goes away or is reduced. Seems like a similar situation might apply for OO Multis.

@Steven Hamilton II ?

I see. I would talk to a CPA about it because it is complicated. I am pretty sure it would still be their primary residence even with renting out a room.

Originally posted by @Jon Holdman :

@Anthony Dooley   I think @Diana Tian is asking about how to handle a situation where rooms are being rented. I believe that results in the ability to take some depreciation, for the part of the house that's being used as rentals (which seems to be called "house hacking", my great grandma called it "taking in a border"). IDK if that means the $250K exclusion goes away or is reduced. Seems like a similar situation might apply for OO Multis.

@Steven Hamilton II ?

Thanks!  

@Diana Tian  @Jon Holdman  @Anthony Dooley  

As long as you meet ownership and use tests and the space you are renting is "within" your home, you will still qualify for the exemption.

Per the IRS, Pub 523:

If the part of your property used for business or to produce rental income is within your home, such as a room used as a home office for a business, you do not need to allocate gain on the sale of the property between the business part of the property and the part used as a home. In addition, you do not need to report the sale of the business or rental part on Form 4797. This is true whether or not you were entitled to claim any depreciation.

Originally posted by @Brandon Hall :

@Diana Tian @Jon Holdman  @Anthony Dooley  

As long as you meet ownership and use tests and the space you are renting is "within" your home, you will still qualify for the exemption.

Per the IRS, Pub 523:

If the part of your property used for business or to produce rental income is within your home, such as a room used as a home office for a business, you do not need to allocate gain on the sale of the property between the business part of the property and the part used as a home. In addition, you do not need to report the sale of the business or rental part on Form 4797. This is true whether or not you were entitled to claim any depreciation.

Thanks for explanation.

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