Rent back / Use and Occupancy Agreement post home purchase. Anything deductable?

[drdavidge]

Hi,

We currently own a home but are also purchasing another home to move into in a year. We planned closing on the purchase in September, renting out the house until the renovation plans were finalized in February (to either profit or cover some/all of the carry costs), starting renovations in March, and moving in during the summer. We secured an investor mortgage just to keep the paper trail clean. The seller expressed interest in staying so we wound up doing a use and occupancy agreement for 5 months, but at a rate below market rate and below our mortgage payment and taxes. While the rate was lower, it was easier to keep the sellers in the house rather than finding a short term renter and dealing with a tenant. For ease of numbers, say they agreed to pay $3000 in rent, our mortgage payment is $5500 (with $4000 in P&I and $1500 in taxes), and the appraised rental market rate was $5100.

Questions are..

1) Is there a loss to take here somehow and is that deductible?

2) Are there any other deductions that can be taken?

3) Can you deduct mortgage interest or taxes on both properties?

4) If I do any work to the property or fix any issues while they are there, is that deductible?

5) How do you express this in TurboTax?

6) Are there any considerations I am missing?

Thanks!

[Critter-3]

FIRST ... your mortgage payment is immaterial to this situation so stop using that as a measuring point. 

Questions are..

1) Is there a loss to take here somehow and is that deductible?  Maybe if you are renting at fair market value  even if your mortgage payment is larger than what you take in.

2) Are there any other deductions that can be taken?  All rent received will be reported on the Sch E and all expenses for that rental period which will include (but not limited to) mortgage interest, RE taxes, utilities, maintenance/repairs AND depreciation (principle portion of the mtg pmt taken this way per IRS rules).

3) Can you deduct mortgage interest or taxes on both properties?   Yes ... the personal portion on the Sch A and the rental portion on the Sch E ... the common expenses for a mixed use year will have to be prorated.

4) If I do any work to the property or fix any issues while they are there, is that deductible?  It will either be a deductible expense n the Sch E  or  add to the depreciable basis. 

5) How do you express this in TurboTax?  You just follow the interview screens to enter the Sch E and Sch A expenses. You may want to use a local tax pro the first year to get this set up correctly and maybe the second year to close out the Sch E  or  upgrade to one of the LIVE online options  or   educate yourself.

6) Are there any considerations I am missing?  I think you need to do some reading ... start here :  https://www.irs.gov/taxtopics/tc414

[Carl]

The current response appears to me, to be making assumptions that I'm not clear on.

We currently own a home but are also purchasing another home to move into in a year. We planned closing on the purchase in September,

So as it stands "today", at this very moment in time, you only own one home.

renting out the house until the construction plans were finalized in February (to either profit or cover some/all of the carry costs), starting construction in March, and moving in during the summer.

This is what throws me. Renting out which house? Based on the information provided, it appears you are buying land and construction of a house on that land will not start until March 2023 at the earliest. So you only have one house, and will continue to have only one house until construction is complete. So what is it you are going to rent out? The house you own "right now"? Where are you going to live?

Another interpretation is that you have sold the house you are living in "right now" (or will be closing on the sale in Sept 2022) and then you will be renting it from the buyer for about 5 months. Other than you may or may not have to pay taxes on any gain realized from the sale, you get no tax breaks on your federal tax return as a renter. State taxes "may" be a different story, depending on what state, and if that state taxes personal income.  It also matters how things are worded and set up for the "rent back" terms in your sales contract.

Can you please confirm with more detail so that we "know" without a doubt you're being provided accurate information. You probably are - but lets be sure on that.

[drdavidge]

Let me clarify...

- I own House 1 and live in it.

- I just purchased House 2 and now own two houses. The sellers are living there under a use and occupancy agreement until February. After Feb, House 2 is vacant while we renovate it.

- Renovations get completed in July, and we move into House 2.

- We will decide if we are selling House 1 at that point.

[Carl]

In the thread at https://ttlc.intuit.com/community/taxes/discussion/how-to-handle-a-leaseback-on-a-new-home-purchase/...

Scroll down to the 10th response in that thread, which is my response. Read the whole thread of course. But I'm referencing my response in that thread, which is the 10th one down.

[drdavidge]

Thanks, just gave that a read. But I'm still a bit confused.

Given the example numbers here...

Appraised rental value: $5000

Use and occupancy rate ('rent'): $3000

Mortgage: $4000 P&I + $1500 prop taxes = $5500.

Is anything deductible? Mortgage interest? Property taxes? And as a stretch.. any sort of loss for only receiving $3k vs an appraised value of $5k?

Is it easiest to just have the $3k * 5 months = $15k reduce the cost basis rather than claiming it as income? I don't understand why that would be taxed since it effectively is reducing our purchase price in exchange for handling over control at a later date.

Appreciate the expertise here - thanks.

[Carl]

There's no such thing as an "appraised" rent value when it comes to taxes. Either you're renting at or above FMRV, or you're not. Period. The FMRV is basically, what a renter is willing to pay. The IRS looks at it as compared to rents charged for comparable houses in the same general neighborhood.

When you're renting at below FMRV, then you are considered to not be renting for profit. Therefore, your deductions are limited to the income and may not exceed that. So no losses can be claimed. Keep in mind also that the period of time to seller is living in it after your closing date of the sale is "unqualified use", and this will matter if/when you sell the property down the road and the "2 of last 5" rule comes into play.

All of this is covered is IR Pub 527 at https://www.irs.gov/pub/irs-pdf/p527.pdf

When renting for less than 1 year you are not required to depreciate the property, and I suggest you not depreciate. Otherwise, it's something you have to track for the entire time you own the property.

Keep in mind that when classified as a rental, only the mortgage interest portion of the mortgage payment is deductible, and that has to be pro-rated for the period of time the property was not classified as a rental.  The principle part of the mortgage payment is never deductible. If you pay for mortgage insurance (different from property insurance) then that may or may not be deductible (prorated of course) depending on  your specific circumstances. The program will "Know" based on the data you enter.

Homeowner's insurance is not deductible as an itemized deduction on SCH A. However, you can deduct a prorated amount on SCH E for the period of time it was a rental.

There is no such thing as "start up expenses" for residential rental property reported on SCH E.

Overall, you're better off in the long run to just report the income as miscellaneous income and not deal with the SCH E, since you're only talking about 5, maybe 6 months here. This way, the only thing you have to deal with in the future, is the 5-6 months of unqualified use when the property was not your primary residence.

[Critter-3]

If you rent a property over more than one tax year you ARE required to take depreciation it is only if the property was placed in service AND taken out of service in one tax year that depreciation is NOT  a requirement. 

[Carl]

Ah yes! To further clarify, if claimed on SCH E as rental property, since the property would be placed in service as a rental in 2022 and taken out of service and converted to personal use in 2023, then you are required to take depreciation. Doesn't matter that it's less than 12 months. It does matter that the in service period crosses from one tax year into the next tax year.

You will need to keep records of this for the entire time you own the home, as the depreciation will come into play when any one or more of three things happens in your life.

1. You later convert the property back to a rental. (prior depreciation matters, as it will reduce the cost basis for future depreciation.)

2. You sell the property. (All prior depreciation is recaptured and taxed in the tax year you sell the property.)

3. You die. (This may or may not affect things, depending on your state and how things are set up in a will or estate, for what happens upon the property owner's passing.)

[AmeliesUncle]

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@drdavidge wrote:

but at a rate below market rate and below our mortgage payment and taxes.

No rental expenses are able to be used if it is rented at less than Fair Market Value.

The income would be reported as "other" income (NOT on Schedule E).

Any mortgage interest and real estate taxes would be treated as if it were a second home - possibly deductible on Schedule A as an Itemized deduction (but potentially subject to limitations).

The fact that the home won't always be your main home for the entire time you owned it will affect the exclusion when you eventually sell that property (the exclusion will be prorated).