Tax writeoff rennovations on a duplex with a FHA loan?
I recently purchased a duplex and in order to do so I used an FHA loan. The FHA loan requires me to have one of the units as my primary residence for a minimum of 1 year from my move-in date. I plan on moving out as soon as the year is up so I can rent the entire duplex out to collect income off of it. Since I reside in one side can I only expense the depreciation of 1/2 the purchase price over 27 1/2 years within the first year? Is there a way that I can depreciate the entire purchase price after I move out and rent out both units? Also if I want to make "regular" maintenance rennovations to my side (paint, siding, drywalling, carpet, etc) within the first year I am living there is there any way that I can expense that off of my income?....I read this in an article regarding a question kind of similar to mine:
If a paint job is part of a major remodeling of the entire property, it -- and the rest of the remodeling -- would be treated for tax purposes as a capital improvement. That means the expense would have to be depreciated over a 27 1/2-year period, beginning when the project is completed.
Can I declare my major remodeling of the entire duplex starting this year, keep all of my receipts for the entire remodel and then declare it completed the day I move out and its rented to someone else and expense everything after that? I am hoping there is a gray area or crack I can slip through in the ruleing on expensing rennovations I do this year, as it is much easier to do them while im living there.
Any help on this is appreciated.....
- 9 years agoFavorite Answer
I would suggest a consultation with a local CPA or EA who specializes in small business taxation with some emphasis on rental properties.
For depreciation purposes the first hurdle is that can't depreciate the land, only the house itself, so you need to break out the cost of the land and the cost of the house separately. I've had that challenged before, so a professional appraisal is a wise idea. At least have information on the costs of empty lots in the area (assuming that there are any) for your historical records.
You'll have to depreciate each side separately since you'll be living in one side and renting out the other. You can't depreciate the side that you are living in until you convert it to rental use.
Your basis for depreciation on the rental side will be your original cost basis plus cost of any major repairs or renovations directly related to the rental unit. Common renovations (such as a new roof) must be apportioned between the two. Painting does not qualify as major renovation unless you repaint the entire property or are repairing damage left by a prior tenant so you can often deduct the cost as a maintenance expense. Of course, painting the side that you live in isn't deductible, only the rental side.
Once you move out and convert the other side, you'll need to get a formal appraisal from a licensed appraiser. Your basis on the side that you occupied will be the lesser of the original basis plus any renovations or the fair market value at the time of the conversion. Use that appraisal to apportion between the two sides. The basis of the original rental won't change but if property values dropped the basis on your old residence may be less.
There are not may cracks to slip through on maintenance expenses vs capital improvements. Painting is one that you sometimes can get through as an expense but if you painted the entire property inside and out the IRS may see that as a capital improvement. All renovations are tracked separately but are depreciated on the same 27 1/2 year schedule as the building is.
Also watch out for the active participation rules. You must actively participate in the rental activity in order to take any tax losses in excess of your rental income. That does not mean that you can't turn it over to a property manager for routine day-to-day management (which I highly recommend) but you must retain major decisions such as final approval of all proposed tenants and approval of all major expenditures for repairs and renovations.
Another tripping point are the passive activity loss limitations. If your AGI is too high, you can't show a loss greater than your rental income but must carry it forward. (There's also an at-risk rule but if you have a mortgage on the property or bought it with your own funds, that won't come into play.)
The final "gotcha" is the depreciation recovery when you sell. Depreciation allowed OR ALLOWABLE is recovered at sale time and is taxed at a higher rate than normal long term capital gains, up to 25%. Any passive activity losses carried forward because of the passive activity loss limitations can help to reduce that hit.
As you can see there's a lot to consider and many potential traps in rental property, so I'm back to my recommendation of a consult with a local tax pro before you paint yourself into the proverbial tax corner.
- mrreliable3599Lv 79 years ago
No, you can't "declare" anything into the Internal Revenue Code.
You have two properties. You have a rental property, and personal-use property. When you move out, then you'll have two rental properties.
You have complicated interest-tracing rules to determine which of your payments are interest and which are principal when dealing with a multiple-use loan.
You have correctly identified the issue of improvements vs. repairs having a major impact on recovery of your costs. This is exactly enough knowledge to make a person very dangerous to him or herself.
Get professional assistance. Tax compliance with a duplex, including depreciation, repairs, capitalization, expensing provisions, interest tracing, loss limits, and basis adjustments, is not a do-it-yourself project.
- troLv 79 years ago
what you do while you are living in it is 'living expenses' and not deductible
as for the depreciation, when you start renting the 2nd unit you will establish the depreciation for that half in that year, for the 27.5 yrs, the other one is just 1 yr ahead of #2
adding to the basis of the 2nd unit would depend on what you did to increase its value, painting, fixing the cracks etc is not
if you added more space or enlarged it somehow to increase the value that is increasing your basis and subject to different amount of depreciation
builders will tell you that renovating a bathroom or a kitchen makes your place more sellable, but it is not increasing the assessed value of your home--a patio, a pool, another room,possibly a garage where there was not one, increases value
- Cathi KLv 79 years ago
You can start including expenses for your side once you move out. If you move out in Nov or Dec then it is only 1 or 2 months worth. Any improvements done before you move out may be added to your basis. General maintenance on your home is not deductible.