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Come play FWF Real Estate Attorney - First House Options

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rated:
Hi FWF, I've been thinking about purchasing first house recently.  I have plenty of $ saved up for conventional financing and my retirement is in decent shape and being maxed every year, so not really wanting the thread to go in that direction.

My questions are more aimed at tax avoidance options.  I live with my GF, who for insurance purposes is my domestic partner.  The option I am considering due to tax advantages is purchasing in my name, renting some portion of the house back to her, and then being able to claim depreciation in addition to the mortgage interest that Id already be deducting.  

Questions:
Can I rent my primary residence to someone and claim it as both my primary residence and an investment property for rental/depreciation purposes?
Does her being my domestic partner change any of this?
Does the portion rented need to be 50/50 or can I rent 90/10 for example to maximize the depreciation portion allowed?
Would this house be subject to capital gains on appreciation under either the 1031 exchange rules for an investment property or primary residence so that I can defer the depreciation recapture?

Any other reasons this is a good or terrible idea?

 

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rated:
You're going to have to pay income taxes on the rent you get.

You already get mortgage interest deduction on your primary. And of course, exempt from cap gains taxes.

rated:
1.  If you tell the mortgage lender what you are up to (and you should) probably will pay much higher interest rate.

2. When time comes to sell probably will have problems with the $250K/$500K tax free capital gain allowance.

rated:
Practically speaking there is no situation where you would pay taxes on the rent as income as long as you are not taking in more money than you are spending. Either your girlfriend is contributing to your household expenses and it is neither income nor a gift, or she is paying rent and your deductions will be greater than the rent taken in.

You would lose money if you treat the property as an investment property when paying back the depreciation. Your deductions before depreciation will be more than your rental income so any depreciation will not save money in the short term and will require you to pay it back when you sell. If you were renting out multiple rooms it would make more sense to do this. You would also lose out on the homeowners exclusion on gains on the investment portion

rated:
Would you still be able to get HO insurance as owner occupied? Would your rates be higher with a "tenant" living with you?

rated:
gnopgnip said:    she is paying rent and your deductions will be greater than the rent taken in.

 

  You can't be certain of this, OP must rent it out at market rate, he can't just rent it for $1

rated:
I'm 99% certain she can't be your domestic partner for insurance purposes AND not your domestic partner when it comes to rent.

What paperwork did you sign when you claimed her as a domestic partner at work?

rated:
https://www.irs.gov/taxtopics/tc415.html

If you receive rental income for the use of a dwelling unit, such as a house or an apartment, you may deduct certain expenses. These expenses, which may include mortgage interest, real estate taxes, casualty losses, maintenance, utilities, insurance, and depreciation, will reduce the amount of rental income that's subject to tax.

Seems quite clear cut if she is your girlfriend but the domestic partnership cloud things up. Even if you can do this, the benefit may not be worth the cost (tax).

rated:
I (naively) thought I could offset regular wage-slave income with rental deductions as well; if not it severely limits any upside to doing this. See here for discussion on whether or not it would be treated as passive losses... http://www.nolo.com/legal-encyclopedia/can-you-deduct-your-renta...

I didn't sign anything re: domestic partnership, my HR department was very lax about the whole thing.

Haven't checked on HO insurance but this is another good point.

After reading the link from Zen & https://www.irs.gov/pub/irs-pdf/p527.pdf it looks like I'm not the first person to consider this, any upside would be minuscule after hiring RE atty/accountant & spending many hours of my life figuring out how to jump through the hoops.

rated:
jd2010 said:   I (naively) thought I could offset regular wage-slave income with rental deductions as well;
You can but only if your wage slave Income is under certain level. But even then you will have to income the rent as income. And no you can't just charge her $1
Property owners with modified adjusted gross incomes of $100,000 or less may deduct up to $25,000 in rental real estate losses per year if they "actively participate" in the rental activity. You actively participate if you are involved in meaningful management decisions regarding the rental property and have more than a 10% ownership interest in the property. This allowance is phased out for taxpayers whose MAGI exceeds $100,000 and eliminated entirely when it exceeds $150,000. Thus, it is useless for high-income landlords.

rated:
jd2010 said:   Hi FWF, I've been thinking about purchasing first house recently.  I have plenty of $ saved up for conventional financing and my retirement is in decent shape and being maxed every year, so not really wanting the thread to go in that direction.

My questions are more aimed at tax avoidance options.  I live with my GF, who for insurance purposes is my domestic partner.  The option I am considering due to tax advantages is purchasing in my name, renting some portion of the house back to her, and then being able to claim depreciation in addition to the mortgage interest that Id already be deducting.  

Questions:
Can I rent my primary residence to someone and claim it as both my primary residence and an investment property for rental/depreciation purposes?
Does her being my domestic partner change any of this?
Does the portion rented need to be 50/50 or can I rent 90/10 for example to maximize the depreciation portion allowed?
Would this house be subject to capital gains on appreciation under either the 1031 exchange rules for an investment property or primary residence so that I can defer the depreciation recapture?

Any other reasons this is a good or terrible idea?

 

  
This convoluted plan sounds like a nightmare waiting to happen on multiple fronts...

rated:
jd2010 said:   Hi FWF, I've been thinking about purchasing first house recently.  I have plenty of $ saved up for conventional financing and my retirement is in decent shape and being maxed every year, so not really wanting the thread to go in that direction.

My questions are more aimed at tax avoidance options.  I live with my GF, who for insurance purposes is my domestic partner.  The option I am considering due to tax advantages is purchasing in my name, renting some portion of the house back to her, and then being able to claim depreciation in addition to the mortgage interest that Id already be deducting.  

Questions:
Can I rent my primary residence to someone and claim it as both my primary residence and an investment property for rental/depreciation purposes?
Does her being my domestic partner change any of this?
Does the portion rented need to be 50/50 or can I rent 90/10 for example to maximize the depreciation portion allowed?
Would this house be subject to capital gains on appreciation under either the 1031 exchange rules for an investment property or primary residence so that I can defer the depreciation recapture?

Any other reasons this is a good or terrible idea?

 

  I think you'll have much better answers if you post a pic of your GF.

rated:
speedracer714 said:   
jd2010 said:   Hi FWF, I've been thinking about purchasing first house recently.  I have plenty of $ saved up for conventional financing and my retirement is in decent shape and being maxed every year, so not really wanting the thread to go in that direction.

My questions are more aimed at tax avoidance options.  I live with my GF, who for insurance purposes is my domestic partner.  The option I am considering due to tax advantages is purchasing in my name, renting some portion of the house back to her, and then being able to claim depreciation in addition to the mortgage interest that Id already be deducting.  

Questions:
Can I rent my primary residence to someone and claim it as both my primary residence and an investment property for rental/depreciation purposes?
Does her being my domestic partner change any of this?
Does the portion rented need to be 50/50 or can I rent 90/10 for example to maximize the depreciation portion allowed?
Would this house be subject to capital gains on appreciation under either the 1031 exchange rules for an investment property or primary residence so that I can defer the depreciation recapture?

Any other reasons this is a good or terrible idea?

 

  I think you'll have much better answers if you post a pic of your GF.

  the IRS doesn't care how hot the GF is

rated:
fwuser12 said:   Would you still be able to get HO insurance as owner occupied? Would your rates be higher with a "tenant" living with you?
  OP would tell IRS one thing and insurance company something else.

rated:
rufflesinc said:   
gnopgnip said:    she is paying rent and your deductions will be greater than the rent taken in.

 

  You can't be certain of this, OP must rent it out at market rate, he can't just rent it for $1

  The market rate for half of a house is going to be less than the mortgage interest, insurance, property taxes, repairs, utilities, and any other qualifying expenses. Especially the first few years when almost none of your money is going towards equity. I would not be surprised if the rental income for renting out a whole house was less than the expenses in the more expensive metros, excluding depreciation. A three bedroom home in San Jose can be over a million. The rent will be $3250. The monthly payment on that mortgage will be $4800 and only a few hundred of that is towards the principle. Here is a place as an example. https://sfbay.craigslist.org/sby/apa/6020172615.html https://www.zillow.com/homedetails/1362-Antonio-Ln-San-Jose-CA-9...

Even if you can deduct depreciation against your normal income you have to pay depreciation back when you sell so it is mostly a wash. If you make over $150k and are not a real estate professional you can not write off real estate losses on your regular income. Between 100 and 150 it is graduated and under $100k you can write off up to 25k a year in losses. It is only in the 91k+ single bracket where your marginal tax rate is higher than the depreciation rate cap of 25%. If you are making less than 31k a year you would be paying more in depreciation recapture than in taxes on your W2.
You can use a 1031 exchange to defer the depreciation further, or if you die your heirs get your property on a stepped up basis without the IRS recapturing the depreciation. 

rated:
gnopgnip said:   
rufflesinc said:   
gnopgnip said:    she is paying rent and your deductions will be greater than the rent taken in.

 

  You can't be certain of this, OP must rent it out at market rate, he can't just rent it for $1

  The market rate for half of a house is going to be less than the mortgage interest, insurance, property taxes, repairs, utilities, and any other qualifying expenses. 

  half of those as well . The OP can't deduct 100% of the expenses if he's only renting out half the house.

rated:
OP - it isn't worth it.

1) you have to charge market rent, and pay taxes on it.
2) yes you can probably depreciate a portion, but depreciation isn't worth that much - you have to recapture all of it when you sell!
3) you will have to pay taxes on part of the gain when you sell. this is bad. will probably wipe out any other positives.

rated:
For future reference, how would this be treated from a cap gains perspective?

Primary residence is obviously not taxed.
Rental properties can be 1031 exchanged within X timeframe, and you can perpetually defer cap gains/depreciation recapture.

But what happens if your primary residence is also a rental property?  I'm assuming half the house would be cap gains free and the half that was depreciated would have to be reinvested within the timeframe under 1031 or would trigger tax liability?

rated:
jd2010 said:   For future reference, how would this be treated from a cap gains perspective?

Primary residence is obviously not taxed.
Rental properties can be 1031 exchanged within X timeframe, and you can perpetually defer cap gains/depreciation recapture.

But what happens if your primary residence is also a rental property?  I'm assuming half the house would be cap gains free and the half that was depreciated would have to be reinvested within the timeframe under 1031 or would trigger tax liability?

  
This is a good but complicated question.  Depreciation recapture on a house I also lived in before renting it is the single hardest tax issue I have ever had to deal with.  I haven't researched this exact situation, but I am skeptical you can utilize the 250k appreciation exemption and do a 1031 exchange.  The depreciation lowers the basis in your house, so you have to recapture it first before you can calculate your basis to take advantage of the 250k appreciation exemption.  1031 exchanges already are hassles and can add fees for escrowing the funds.  As you noted, this type of transaction is unusual enough that you would probably have to seek specialized tax advice (I wouldn't trust just any CPA), the cost of which would eat into any benefits.  

Another consideration is that I believe depreciation recapture is a fixed 25%, which may or may not be a good deal depending on your typical marginal tax rate.   

Finally, keep in mind that if you rent out the space at below market rates (especially to family members or friends), the IRS may argue you are engaged in a not-for-profit activity.  This is disastrous from a tax perspective because you can't deduct losses beyond your rental income on the property, and you don't get to carry over losses to future years.  Further, you have to take the deductions on Schedule A instead of Schedule E, which isn't worthwhile if you aren't above the standard deduction.  

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