Tax Implications for Rehab Costs House Hacking

11 Replies

I am currently house hacking and occupy nearly 50% of the square footage. Our unit is also going to be the primary rental unit when we move out and will pull in the majority of the income. 

Our unit has been kind of run down by previous long term tenants. We are doing a lot of small repairs this year while we live here but I have been putting off any more expensive items until we move out, under the assumption that once we move out, we can write off the cost of those items (example, window replacement).

Is there a trick for making these major improvements now- but with the ability to write off some of the expense? Or does it make sense to just wait? 

I know with the new laws, it is easier to write off improvements in the current year, so I am inclined to wait and take the full write off next year when we turn it into a rental. But curious how others are handling rehab costs for their house hacks. Thanks!

You are converting a primary to a rental.....I believe your “basis for depreciation” is the lower of......your purchase price plus improvements OR current fair market value, whichever is lower, but I’m not a cpa.  Gets a little more complicated I guess when living in half of a duplex.

Originally posted by @Sabrina Savinski :

I am currently house hacking and occupy nearly 50% of the square footage. Our unit is also going to be the primary rental unit when we move out and will pull in the majority of the income. 

Our unit has been kind of run down by previous long term tenants. We are doing a lot of small repairs this year while we live here but I have been putting off any more expensive items until we move out, under the assumption that once we move out, we can write off the cost of those items (example, window replacement).

Is there a trick for making these major improvements now- but with the ability to write off some of the expense? Or does it make sense to just wait? 

I know with the new laws, it is easier to write off improvements in the current year, so I am inclined to wait and take the full write off next year when we turn it into a rental. But curious how others are handling rehab costs for their house hacks. Thanks!

 
Sabrina, 

The improvements that you make to your side of the unit will have to be added to the basis of the property. So you will not lose on the expenses if you make improvements. If you do repairs, its a personal expense. 

Two things:

Rapairs:

1) Repairs made on the personal side of the duplex cannot be deducted. It is a personal expense, just like your food expense.

2) Repairs made on the duplex are deductible against the rental income.

Improvements:

1) Improvements made on the personal side are added to the basis of the property, but you cannot depreciate the personal side of the property until you move out. The increase of the basis will help you minimize the taxable gain when you eventually sell the house. So, basically you dont lose the money spend. 

2) Improvements made on the rented side will also be added to the basis, but you can depreciate the improvements on the rental side and deduct depreciation against the rental income. But, you have to recapture the depreciation (pay taxes again on what was deducted ) at the end when you sell the house.

So, a good strategy is:

A) For the personal side, do not do repairs because they are personal. Always do improvements because they increase your basis thus reduce taxable gain in the future or will eventually increase your expense when you move out. 

B) For the rental side, do repairs because they are deductible right away and do not have to depreciate over a few years as done for improvements. Repairs do not have to recapture when you sell the house too.

@Sabrina Savinski

I need to add to what @Ashish Acharya said about your personal unit.

Example 1. You completely redo the bathroom in your unit for $10k. Whether you do it now or after you move out, you will end up depreciating this $10k next year when you convert it to a rental. Advice: no need to wait.

Example 2. You change carpets in your unit for $2k. If you wait a year, you will be able to write off $2k. If you replace it now, you will be able to write off maybe $1.5k next year. $1.5k being the estimated fair market value of a carpet lightly used for 1 year. So, you will sacrifice a small deduction, but you will live with a new carpet - should be worth it. Advice: don't wait.

Example 3. You repaint the entire unit for $3k. It's not deductible if you do it now, but is deductible if you do it in preparation for renting. Advice: wait if the current paint does not bother you too much.

Originally posted by @Michael Plaks :

@Sabrina Savinski

I need to add to what @Ashish Acharya said about your personal unit.

Example 1. You completely redo the bathroom in your unit for $10k. Whether you do it now or after you move out, you will end up depreciating this $10k next year when you convert it to a rental. Advice: no need to wait.

Example 2. You change carpets in your unit for $2k. If you wait a year, you will be able to write off $2k. If you replace it now, you will be able to write off maybe $1.5k next year. $1.5k being the estimated fair market value of a carpet lightly used for 1 year. So, you will sacrifice a small deduction, but you will live with a new carpet - should be worth it. Advice: don't wait.

Example 3. You repaint the entire unit for $3k. It's not deductible if you do it now, but is deductible if you do it in preparation for renting. Advice: wait if the current paint does not bother you too much.

Thanks Micheal. Can you please kindly elaborate on the example 2. How will she be able to write off 1.5k of carpet when she moves out that originally cost 2k when she was living in it and was personal expense ? 

Originally posted by @Ashish Acharya :
Originally posted by @Michael Plaks:

@Sabrina Savinski

Example 2. You change carpets in your unit for $2k. If you wait a year, you will be able to write off $2k. If you replace it now, you will be able to write off maybe $1.5k next year. $1.5k being the estimated fair market value of a carpet lightly used for 1 year. So, you will sacrifice a small deduction, but you will live with a new carpet - should be worth it. Advice: don't wait.

Thanks Micheal. Can you please kindly elaborate on the example 2. How will she be able to write off 1.5k of carpet when she moves out that originally cost 2k when she was living in it and was personal expense ? 

She will be placing this asset (carpet) in service. Used 5-yr property eligible for Sec 179 or bonus depreciation or de minimis - choose your favorite method. The basis is the lower of cost ($2,000) or FMV ($1,500).

Originally posted by @Michael Plaks :
Originally posted by @Ashish Acharya:
Originally posted by @Michael Plaks:

@Sabrina Savinski

Example 2. You change carpets in your unit for $2k. If you wait a year, you will be able to write off $2k. If you replace it now, you will be able to write off maybe $1.5k next year. $1.5k being the estimated fair market value of a carpet lightly used for 1 year. So, you will sacrifice a small deduction, but you will live with a new carpet - should be worth it. Advice: don't wait.

Thanks Micheal. Can you please kindly elaborate on the example 2. How will she be able to write off 1.5k of carpet when she moves out that originally cost 2k when she was living in it and was personal expense ? 

She will be placing this asset (carpet) in service. Used 5-yr property eligible for Sec 179 or bonus depreciation or de minimis - choose your favorite method. The basis is the lower of cost ($2,000) or FMV ($1,500).

 Nice. I never thought of treating carpet as the asset and depreciating/"bonusing" it separately like that after it has been converted. Thanks for sharing that.  However, she will not be able to take section 179 as it was a personal asset before. 

@Ashish Acharya

“A) For the personal side, do not do repairs because they are personal. Always do improvements because they increase your basis thus reduce taxable gain in the future or will eventually increase your expense when you move out.”

Do you mind explaining the increasing of basis to reduce taxable gain? (Above) I am not sure I really understand this and I feel like this would help me as I am currently owner occupying a duplex with plans to move out at some point in the next few years as well and with the need to do both improvements and repairs to the side we are living in and the rental side.

Originally posted by @Stephen Betteridge :

@Ashish Acharya

“A) For the personal side, do not do repairs because they are personal. Always do improvements because they increase your basis thus reduce taxable gain in the future or will eventually increase your expense when you move out.”

Do you mind explaining the increasing of basis to reduce taxable gain? (Above) I am not sure I really understand this and I feel like this would help me as I am currently owner occupying a duplex with plans to move out at some point in the next few years as well and with the need to do both improvements and repairs to the side we are living in and the rental side

Improvements increases the basis of the property. When you eventually sell it, your gain is difference between sale price and basis. So your gain is lower. You don’t lose the improvements. 

Or when you change the personal asset to rental, you can start depreciation on the basis of the property. Since your improvements got added to the basis of the property, your depreciation expense is higher.