Investors & landlords

I see all kinds of problems here. I'll try my best to keep it as simple as possible. But it won't be easy.

1. The first thing to understand is that you can not deduct from your taxable income, that which can not be taxed in the first place. That means your son's "free" labor is not deductible on any tax return. Not ever.

2. My son lives in it for free.  When reporting that you are "renting" to family, that's an automatic flag raiser with the IRS. That's because there are additional rules that come in to play when renting to family. One of those rules has to do with renting the property at Far Market Rental Value (FMRV). Most of the time those renting to family charge well below the FMRV. When you do that, then carry over losses are not allowed. So you can only deduct the rental expenses up to your actual rental income for the year and that's it. Any additional expenses that exceed the rental income can not be carried over to the next year. You just lose it. Forever. That can (and will) hurt tax-wise big time later down the road when one of three things happens in your life. A) You sell the property, B) You lose the property due to something like a fire, hurricane or other disaster, or C) You die.

3. This is a family home that has been passed from person to person in the family for years, I have no purchase cost.  Actually, you do have a purchase cost, referred to as your cost basis. What that cost basis is, depends on "exactly" how you acquired the property. If you were given the property by the prior owner prior to their passing away, then as far as the IRS is concerned, it was a gift. A part of that gift would also be the original owner's cost basis, or what they paid for the property. So if the prior owner purchased it in 1960 for $3500 and when they gave it to you in say, 2010 it was worth $100,000, your cost basis is still $3500 since the IRS considers that original cost basis as a part of the "gift" given to you also.

Now if you inherited the property from the prior owner after that prior owner passed away, be it through a will or probate, then your cost basis would be the Fair Market Value (FMV) of the property on the date the prior owner passed away. *NOT* the date your name was put on the deed after the prior owner passed away. That FMV is generally determined by a licensed appraiser, and *NOT* by the county property appraiser. Remember, the county property appraiser only asses tax value for property tax purposes - not resale value. So typically the tax value will be anywhere from 25% - 40% lower than the true market resale value.

3. but did pay for new roof, gutters, lots of structural repairs, and basically gutted the interior to make it livable.  Absolutely none of what you state would be classified as a repair in the eyes of the IRS. Instead, they are property improvements. What's the difference you ask? Here's the "plain english" definitions of property improvements and repairs.

a) Property Improvement.

Property improvements are expenses you incur that add value to the property. Expenses for this are entered in the Assets/Depreciation section of the SCH E and depreciated over time. Property improvements can be done at any time after your initial purchase or acquisition of the property. It does not matter if it was your residence or a rental at the time of the improvement. It still adds value to the property.

To be classified as a property improvement, two criteria must be met:

1) The improvement must become "a material part of" the property. For example, remodeling the bathroom, new cabinets or appliances in the kitchen. New carpet. Replacing that old Central Air unit.

2) The improvement must add "real" value to the property. In other words, when  the property is appraised by a qualified, certified, licensed property appraiser, (not your county property tax appraiser.) they will appraise it at a higher value, than he would have without the improvements.

b) Repair

Those expenses incurred to return the property or it's assets to the same usable condition they were in, prior to the event that caused the property or asset to be unusable. Repair expenses incurred are only deductible if incurred while the property is classified as a rental. Repair costs incurred in the process of preparing the property for rent are not deductible.

c) Additional clarifications: Painting a room does not qualify as a property improvement. While the paint does become “a material part of” the property, from the perspective of a property appraiser, it doesn’t add “real value” to the property.

However, when you do something like convert the garage into a 3rd bedroom for example, making a  2 bedroom house into a 3 bedroom house adds “real value”. Of course, when you convert the garage to a bedroom, you’re going to paint it. But you will include the cost of painting as a part of the property improvement – not an expense separate from it.

Now I'll stop here because I think you've learned enough at this point to make an informed decision. However, if you do have more questions then by all means, please ask!