Taxes on rental property with fiancé

15 Replies

Hi all,

This year, my fiancé and I bought and moved into a house, and started renting out the old house. The old house is in just my name (the new house is in both our names). Both our names are on the lease as the landlords for the old house. We will file taxes separately (as we're not yet married). We both have W-2 jobs. Does it make the most sense for just me to claim the rental income and deductions on my taxes, and to leave it off of his? We have talked about setting up some sort of legal partnership, but haven't gotten around to it yet. I'm just not sure where to start with this. I fully intend to consult with a CPA and/or lawyer, but thought I would see if I could get some general thoughts from here first.

Thanks!

@Carolyn Hodo

Who makes more w2 money and how much? Who is in the higher tax bracket? Who gets the bigger bang from the deduction? What is the verbal or written agreement? How have past finances been handled-who paid for what? Who collected the rent or how was it split? Etc.  

I would need the above info to  help make a decision but the cpa can give you the values/$$ involved. 

Good luck!

I'm in the same boat as you. My CPA will be handling this, but I'm assuming since the legal documents will be in my name only, it is up to me to claim said tax deductions. Even if my girlfriend paid all the bills, the duplex is in my name, as well as the mortgage/title, so how can she claim something on taxes that isn't in her name? Not sure the lease being in both your names means anything when it comes to legal tax documents. 

Now, here's a question for CPA's, especially since there are new higher personal deductions on taxes this year. Can Carolyn take her personal standard deduction of $12k on her taxes, and also take the deductions for expenses, taxes, interest, etc on her Schedule E for her rental house? I believe the answer is yes!

@Carolyn Hodo

Thanks for the responses so far! 

@Eamonn McElroy No, we will not be married by Jan 2019. 

@Carl Fischer He makes more W2 money (probably around $35k more for this year - I was a postdoc lol, just got a slightly better-paying job starting this month); he is just barely in the 24% bracket, while I am in the 22%. I also have some investment income - last year it was around $8k combined in capital gains, dividends, and interest income. He has joint custody of 2 children from previous marriage and I believe he gets to claim one of them on his taxes. I have student loans and will have interest from that to deduct (if I itemize??)

This is the first year that we have really commingled finances at all - last year we lived together in that old house, and he just paid me a certain amount for "rent" and bills. Now, the rent from that rental is deposited into a joint checking account and the rental income above the mortgage and percent saved for expenses goes straight toward the mortgage payment on the new house - so we basically split it, and split the rest of the mortgage, utilities, etc. We still have mostly separate accounts and credit cards, etc.

The general agreement between us is that we are in this together - splitting profits and expenses according to relative income or evenly (mine will soon be closer to his) moving forward, but not completely commingling all accounts just yet (I have a lot in investment accounts from an inheritance - I also have a lot of student loan debt). We hope to work toward financial freedom - building some real estate investments is part of that (also likely doing a live-in flip on the new house). I did put more into both fixing up the old house and down payment and remodel costs on the new house, because I had more money available in savings.

Fiance also has a small business - I believe it's in an S-corp now, that he usually does not take income from, but they did do a payout last year which he used as part of the down payment on the new house. He has a lawyer and a CPA that's he's used for that business, so we have talked about talking to them about the real estate stuff, but have not yet done so ($$$). In the past, I've always done my taxes myself with TurboTax and more recently TaxAct, because they have been pretty simple, but I know this year will be more complicated, and I don't even know anything about depreciation except that it's a thing I need to do.

I don't think you can claim 100% of rental income if the rental is under both your names and you are not legally married.  why did you put both your names as landlord if the property is under your name? 

Note you can only claim 50% of rental income, but I assume the mortgage and the property is only under your name.  I believe this means only you can claim the interest deduction, property tax deduction, and depreciation deduction, so the 50% that is reported by your fiance would be 100% taxable without any deductions.

@Carl Fischer "Who makes more w2 money and how much? Who is in the higher tax bracket? Who gets the bigger bang from the deduction? What is the verbal or written agreement? How have past finances been handled-who paid for what? Who collected the rent or how was it split? Etc.

I would need the above info to help make a decision but the cpa can give you the values/$$ involved."

Unfortunately we can't pick and choose whose return to put this on to holistically minimize taxes.  It's not that simple...  The first three questions have no bearing on the correct path to take...

@Anthony Wick "Can Carolyn take her personal standard deduction of $12k on her taxes, and also take the deductions for expenses, taxes, interest, etc on her Schedule E for her rental house?"

Yes, that's how it works pre and post TCJA.  Doesn't matter if you take the standard deduction or itemize...

@Carolyn Hodo

I would be very careful about potentially adding him to the title or splitting income and expenses before you're married.  Adding to the title may create gift tax exposure.  Splitting income and expenses might be deemed a general partnership and necessitate a 1065 obligation.

Won't matter after you're married....

I imagine you are the only person on the insurance policy, on the mortgage note, and on the county tax assessment as well as the title....  It's arguable that you have the strong majority of 'burden of ownership' and the rental belongs on your Schedule E.  Money to him could possibly be a gift or a management fee.

Arguable that you're complicating the situation from a tax perspective by bringing him on before you're married.

I would consult an attorney before adding him to the title.  Pros...cons...etc vs keeping it in your name indefinitely.

Consult a tax CPA/EA before year end and get the rental situation ironed out.  I'm less concerned about whose names are on the lease agreement (although that has legal implication) and more concerned about the income/expense splitting and the cash flows.

Best of luck.

Thanks @Eamonn McElroy . That's correct, it is only my name on the title, mortgage note, insurance, and county tax. I plan to keep it in my name unless there is some (financial or legal) benefit to adding him.

So, as far as splitting income/expenses, I could argue that I am getting all the income and I just pay more toward the mortgage on the house that we co-own? Or is it a problem that the rent is deposited into a joint account with both our names? Is it a problem that we split expenses for the house that we currently live in together??

I'll work on finding a good CPA. I think it makes sense to have some sort of legal agreement in place too... does it make sense to meet with a CPA first, or a lawyer? Or doesn't matter?

@Carolyn Hodo "So, as far as splitting income/expenses, I could argue that I am getting all the income and I just pay more toward the mortgage on the house that we co-own? Or is it a problem that the rent is deposited into a joint account with both our names? Is it a problem that we split expenses for the house that we currently live in together??"

All great questions to ask your CPA/EA.  : )

"I'll work on finding a good CPA. I think it makes sense to have some sort of legal agreement in place too... does it make sense to meet with a CPA first, or a lawyer? Or doesn't matter?"

I would say an attorney is less of a priority right now than a CPA/EA.

Perhaps add @Michael Plaks to your list of candidates to interview.  He is TX based.

Since you have already put both names on the lease as landlord, you might want to create a separate legal document that makes your finance your unpaid agent empowered to act on your behalf in the day-to-day operation of the rental property.  This is a conversation to have with your attorney.  If the attorney says this is more suited to a limited power of attorney, then go for it.  If you are not married by the time your lease is up for renewal, renew the lease with just your name as landlord.  You can always ask the tenant to sign a 'revised" lease that removes your partner's name as landlord.  A small decrease in the rent for the remaining term of the lease may induce your tenant to sign willingly and eagerly.

Your partner should also consult his attorney to learn whether having his name on the lease as a co-landlord creates a liability exposure for him.  If the tenant sues, the tenant will sue the named landlord(s) and you each may be jointly and severally liable for any judgment the tenant is awarded.   Will he want to accept that risk?

That said, I would not share the rental income with your life parner untill you are married and filing a joint tax return.  Have all the rental income deposited into a property management account titled in your name only.  Pay all your rental expenses from this account, and claim all of the rental activity on your own Schedule E (1040).  

I suggest this because life's plans sometimes go awry.  If your relatioship takes a turn for the worse, you won't have to untangle your roles in this rental activity.  

You have an interesting interaction of business, tax, and family law. The old house is and will likely remain your separate property under TX law. However, without a pre-marital (and sometimes post-marital agreement), the rental income becomes community property once you are married. Community funds spent paying taxes, upkeep, mortgage, etc on separate property are sometimes claimable in a divorce case. Commingling community and separate property presumes the property is community. 

I wouldn't share anything with the fiance; continue reporting your taxes as if you weren't married. You should consider getting a pre-marital / post-marital agreement, even if all it says is that the rents coming from the house remain separate property, so you can use those rents to pay the taxes and upkeed of the house without worrying about a future reimbursement claim in divorce. 

You should also consider whether or not an LLC is appropriate for asset protection purposes; if the house is paid off, a 1 LLC structure and maybe a multi-LLC structure are no brainers. If it's still mortgaged, you have to weigh the risk of a Due on Sale clause / refinancing to a corporate rate loan.

I'd suggest discussing this issue with a lawyer experienced in those issues to get your best options and costs on the legal work.

@Carolyn Hodo

Another thing to consider is to sell the old house before the 5 year limit of section 121 runs out. This will allow you to potentially avoid some or all of the capital gains tax upon sale(won't avoid the depreciation recapture since you starting renting it out).

Hi @Carolyn Hodo

Something I didn't anyone talk about was the home sale exclusion of $250,000

How long did you live in the old house?

How much you paid for it and How much is it worth now if you were to sell it?

Renting without taking the exclusion into account is a big mistake.

Hi @Hector Bilbao and @Basit Siddiqi , Yes I have considered selling the house, but our long term goal is to build up a few income-generating SFH or small multifamily rentals. I bought the house in 2012 for $131k and lived in it until summer 2018. I remodeled the kitchen and bathrooms and replaced the floors with vinyl plank. It's a nice 3/2 in a decent neighborhood, and because of those improvements and general appreciation in the area, I think it's now conservatively worth about $175-185k. It has a mortgage on it, low interest rate (3.5%), with monthly payment of $860 (including taxes & insurance). We have it rented now for $1450/month so pretty good cash flow. Because prices have gone up a lot since I bought that house, I think it's unlikely I'll be able to easily find many other rental properties with a similar cash flow - so that's why we are considering keeping it long term as a rental (and maybe tapping into the equity if I can find a bank that will lend on it as an investment property). That is just my current train of thought but I am welcome to other opinions! I know we still have about 3 years to sell it and still take advantage of the tax benefits. We definitely plan to use that exclusion if we end up slow-flipping the new house.

@Carolyn Hodo

Here is a strategy that will work wonders for you and you don't have to "sell" it.

One possible strategy is to create an S corporation and then sell your home to the S corporation, which would then operate as the landlord for the property. With this strategy:

1. You avoid taxes by using the home-sale profit exclusion of up to $250,000 ($500,000 for joint returns).

2. You create an increase in your rental property’s depreciable basis that generates an increase in depreciation deductions.

@Carolyn Hodo The calculus involved also demands you consider the transactional costs of selling this property and buying another, as well as the projected ROI of the replacement property.

Real estate is illiquid. Transactional costs are high relative to, say, selling a block of stock or bonds. They affect holistic, lifetime ROI.

There are other ways to get a basis step-up without selling the property to a third party.

You should speak with your tax CPA/EA.  Only someone who knows your exact facts, circumstances, and goals will be able to properly advise you.  If you don't have a tax CPA/EA, it may be a good idea to add one to your team as an external partner.  : )