Primary Home and Rental Property

[jennifervphan]

I purchased a duplex this year under a primary home loan however I live in one of the units and rent out the other unit. I read online that you can deduct the closing costs on a rental property such as: inspection fees, mortgage fees (loan application, underwriting fees), title company fees (escrow fees, recording fees, transfer tax, title search) for a rental property but not a primary home.

Can you help me understand if I can still deduct these closing costs? No? Yes? If yes, I am assuming I can deduct half of the total amount since only 1 unit is rented out? 

[GeorgeDenseff]

You can add those costs to the basis of the home when you sell it.  You cannot deduct them while you still own the property.  In your case, you will add the amount that is for the rented portion calculated by the percentage that is rented.

[Critter-3]

The cost basis is calculating the purchase price + cost to buy =  cost basis

(cost basis - land value ) x the rental portion % = depreciable cost basis for the rental ... you MUST take depreciation so do not skip the asset section in the interview ... and the land value for the rental will be zero.   You will divide all common expenses like mortgage interest, taxes, insurance and any shared utilities.  

Read up on the Sch E here :   https://www.irs.gov/forms-pubs/about-publication-527

[Carl]

There are several ways to do this on the tax return. Here's one way which is the way I suggest.

Split *EVERYTHING* in half. Right down the middle. Purchase price, closing costs, mortgage interest, property taxes, property insurance ***EVERYTHING***.

Then on your tax return you treat the rental unit *AS* *IF* it was a physically separate property with 100% business use. The rental unit gets reported on SCH E.

[tagteam]

The following link (to IRS Publication 527) lists the settlement fees and closing costs that can, and cannot, be added to your basis in the property.

Publication 527 (2020), Residential Rental Property | Internal Revenue Service (irs.gov)

[jennifervphan]

@Carl 

2nd question: When I am reporting my rental property income and expenses, let's say my expenses are more than the rental income. Assuming my rental income is $20,000 and my depreciation/expenses are $30,000, leaving me with a difference of $10,000. Can this $10,000 be reduced from my taxable income to lower my taxes owed? Or is the rental expenses just tied to reduce the taxes on the rental income?

This will be my first year reporting my rental unit so I don't know how it works. Thank you.

[jennifervphan]

@tagteam 

2nd question: When I am reporting my rental property income and expenses, let's say my expenses are more than the rental income. Assuming my rental income is $20,000 and my depreciation/expenses are $30,000, leaving me with a difference of $10,000. Can this $10,000 be reduced from my taxable income to lower my taxes owed? Or is the rental expenses just tied to reduce the taxes on the rental income?

This will be my first year reporting my rental unit so I don't know how it works. Thank you.

[jennifervphan]

@Critter-3 

2nd question: When I am reporting my rental property income and expenses, let's say my expenses are more than the rental income. Assuming my rental income is $20,000 and my depreciation/expenses are $30,000, leaving me with a difference of $10,000. Can this $10,000 be reduced from my taxable income to lower my taxes owed? Or is the rental expenses just tied to reduce the taxes on the rental income?

This will be my first year reporting my rental unit so I don't know how it works. Thank you.

[tagteam]

@jennifervphan 

In most instances where rental expenses exceed rental income, the result is a particular type of loss, called a "passive loss".

Per the tax code and regulations, passive losses can only be used to offset passive income (with an exception being the $25,000 special allowance, if you qualify - see link below).

As a result the passive loss from your rental will be carried over to the following tax year.

https://www.irs.gov/publications/p527#en_US_2020_publink1000255996

[Critter-3]

The loss on the rental MAY  be deducted against other income  IF  your income is below the phase out range ... what cannot be deducted currently is carried forward until it can be used or you sell the property.  

[Carl]

Can this $10,000 be reduced from my taxable income to lower my taxes owed?

As stated by others in this thread, Depending on things such as your total income, once your rental expenses (including depreciation) gets your taxable rental income to zero, any expenses left over can be deducted from "other" ordinary income such as W-2 income, up to a maximum of $25,000. Most folks with say 1-3 rentals will be able to do this up to certain amounts not to exceed $25K. Any passive rental losses that can't be deducted just get carried over to the next year.

Now this $25K deduction against "other" income is a fairly recent allowance. So in the past it was most common to have carry over losses every year, with that carry over amount increasing each year. That could still happen to you, if you don't meet all the criteria to deduct your excess rental losses from that "other" ordinary income. That's actually fine.

In the year you sell the property, all disallowed losses that have been carried forward all those years are allowed in full in the year you sell the property. If for other reasons you can't deduct the full amount, (such as having more carry over loss that you do "other" income to deduct it from) then you'll still be able to carry it forward to the next year and deduct it then (possibly with limits). This would continue every year until all of that loss is used up.

[tagteam]

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@Carl wrote:

Now this $25K deduction against "other" income is a fairly recent allowance.

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The allowance has been around just about forever - at least since the 1980's.

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@Carl wrote:

Most folks with say 1-3 rentals will be able to do this up to certain amounts not to exceed $25K. 

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The allowance has no relationship to the number of rentals or vice versa.

[jennifervphan]

@Carl Thank you! Your explanation was very thorough. I do have a follow-up question regarding the $25,000 allowance. I read online that you can apply passive losses up to the $25k amount as long as your MAGI is $100k or less. Any income amount up to $150k will be prorated from the $25k allowance. My question is: how do you calculate MAGI? I read a couple articles and videos online and saw you have to include passive income or passive loss into the calculation. Does that mean I have to include all of my passive rental income and all of my passive loss? So from my previous example, would that $10,000 be reduced from my gross income? Or how would you calculate MAGI?

Thank you!

[jennifervphan]

@Carl Re: "In the year you sell the property, all disallowed losses that have been carried forward all those years are allowed in full in the year you sell the property. "

Just to make sure I understand, so in the year when I sell my property I can apply all of the carried over losses to my "ordinary" income, right?

[Critter-3]

All of the passive losses on the property that was SOLD are released to the Sch E but not all of the passive losses from other properties.