All Forum Posts by: Michael Plaks

@Dalton Dellinger

Business use percentage of everything you listed is deductible.

If asked, you will need to prove to the IRS how much of your phone bills or camera use is for business. Be reasonable, not greedy. For instance, 50% of the cameras is reasonable when you have 2 units.

Home office is tricky, be careful about it. It must be a part of your home not used for anything but business. You cannot use the same area as a guest bedroom or family TV room. Strictly office. Also, you cannot deduct home office if your business shows a loss already.

Thanks for the mention, @Dmitriy Fomichenko.

If I knew a generic answer to your question, @James Maness, I would've been a very rich man, spending 5 minutes a day copy-pasting this answer to every email I receive.

There will be some people replying to this question, telling you their stories - how they got out of the rat race. It's as useful as stories about how someone else found their true love.

However, it's worth discussing your specific circumstances and goals one-on-one with a good tax or financial advisor. You can find several on this forum.

I wonder how many of the attorneys who replied to this thread are going to bill @Caleb Heimsoth for their input?  :)

My response will be free. It's true that Realtors and CPAs, among others, tend to give away their time and knowledge for free. Attorneys and doctors rarely do.

It's interesting how nobody thinks to call (or email) their doctor for a free advice. After all, they have the answers, and it does not take much time. How often do you ask your contractor to simply fix something real quick while he is "there anyway", for free? How about asking the chef for a few tips while at his restaurant?

Just because someone has the knowledge or skills that I don't, does not entitle me to free access to theirs, even in small chunks. They invested time and money to obtain theirs.

Yes, sometimes the policies are too strict and the charges are excessive - but an expectation of free service and advice, no matter how quick it is to administer, is wrong. 

BP is a nice exception where we exchange free knowledge, but we volunteer to do so.

@Lawrence Kaplan

Not sure why you want to sell it to your daughter below your own basis, throwing away the loss in the process.

Ah, now I know where the confusion comes from.

Luckily, you simply misinterpreted this IRS rule, as do 99% of people who read it. (The other 1% is accountants and lawyers.) 

The key word you missed was "presumption." What it means is that if you show more income than expenses for 3 out of 5 years - the IRS will not question if you rented for profit, because it will be automatically presumed to be the case. It does not mean that you must show it, though!

It only means that in all other cases (cannot show positive income for 3 years) you must prove to the IRS that you rented it for profit - IF they raise an objection. Having losses on rental properties is absolutely normal in this business, and the IRS is perfectly aware of it. This "not for profit" conversation only comes if the pattern is really suspicious. For example, you have minimal rent for 3 years in a row, with very large expenses. Even then, you may be able to defend your "for profit" intention, depending on the circumstances.

An analogy: if you wear a police uniform and carry guns - you are presumed to be a legitimate cop (other than in a Terminator movie). Everyone else may need to show his badge to prove his law enforcement status.

@Thomas C.

Let's be sure we're talking about the same thing. "Active participation" is a test required to deduct up to $25k of rental losses against some other type of income, like W2 income, as long as the income is not too high. It's a fairly liberal test where it's enough to simply be involved in decision making - for instance, approving a tenant or a major repair. Property manager is not an obstacle for this test. 10% ownership is part of this deal, too, and it prevents most syndication investors from using this deduction. I have never seen this particular issue audited in 20 years of working exclusively with REI investors.

Passive v. non-passive losses is an entirely different issue which deals with the "real estate professional" status where you need to prove "material participation" - a much more restrictive test. Hiring a property manager does complicate this other situation significantly.

Where did you see this phrase?

The IRS, in fact, states here:

If you don't use the rental property as a home and you're renting to make a profit, your deductible rental expenses can be more than your gross rental income, subject to certain limits. 

I'm just an accountant and not the best to person to answer these. The term "home equity" implies that it is a 2nd position normally. I have no idea how your bank uses the HEL term. Maybe they do mean the first position, but then it just should be called a mortgage. 

And if you're refinancing a rental, the same principle applies. Only a portion of the new loan is deductible against the original rental. It is the portion equal to "acquisition debt" - which is roughly equal to the cost of the property plus the rehab.

Interest on the rest of it can be deducted against the new rental - if it is traceable to the purchase of the second rental.

@Jeff R.

There's no rookie mistake as far as getting the money. It's perfectly normal. There's, however, a rookie confusion about how taxes work on flips. :)

Checks from closing do not matter for tax calculations - not at all. Sounds strange, I know. Bear with me.

For the calculation, imagine the whole deal was done in cash. 

1. You take the sale price from the second closing. This is what you would have received in cash if financing was not involved (minus closing costs).

2. From this number, subtract everything you put into this property:

• initial full purchase price (as if you paid it all in cash)
• closing costs at purchase
• closing costs at sale
• full rehab cost, whether paid from escrowed money or from your cash (because ultimately all of it was paid out of your pocket)
• holding costs like insurance and taxes

This represents your profit, without financing considered.

3. And now subtract the cost of borrowing money: interest and fees. Just make sure to not double-count the fees if you already included them with the closing costs at purchase.

And now you have your true "gross profit."

4. Not done yet. You get to subtract all expenses of running the business: driving, marketing, education and whatnot.

Whatever is left after all your expenses is what you will be taxed on, known as "net profit."

The check you received at sale reflects some pieces of this calculation, but the number on the check is nowhere to be seen in the tax calculation.

You're good. Keep at it. Just may need some tax help.

@Fred Mejias

It's more complicated, actually.

I assume the current mortgage is on your residence. You're refinancing it and using the extra cash to buy a rental property.

To illustrate, let's say your current mortgage is $100k, and you can refinance it into a $150k new mortgage. You extract $50k cash and use it to buy a rental with it. 2/3 of the new loan will still be personal interest for your residence, and 1/3 will be business interest for the rental. 1/3 of your interest is deductible against the rental, and 2/3 of the interest goes on the personal deductions Schedule A - where it is deductible but still may be useless under the new tax law (if your total deductions are below the new standard deduction which doubled compared to the old law.)

Variation. You keep the current mortgage as is, and secure a $60k HEL on top of it. You use the $60k to buy a rental. Then the existing loan's interest remains a personal deduction (again, could be useless under the new law), and the HEL interest is deductible against the rental.

Warning: the $50k/$60k interest is deductible as long as it is traceable to the new property. What it means is that, once you receive the cash, it has to be deposited into a separate account, from where it has to be applied to closing on the new property. If you simply deposit the cash into your normal personal account, mixed with all your other money - you're out of luck. Don't do it to yourself.

PS. You were probably spooked by talk about HELOC deductibility under the new law. It only affects using such loans for personal needs, like buying a car. It does not affect business purposes, such as rental.