Taxes: Primary Home Turned Rental in 2016


#1

Hi Everyone,

I need some advice. As a personal finance enthusiast, I like to understand how taxes work for my personal situation. This year life changed. I accepted an offer in another state and we moved. Instead of seeing our house in Texas, we decided to rent it out to two of our close friends. They were looking for an affordable place and we figured they would take care of it and we could build some more equity. My understanding of the tax law is that we have 3 years after we started renting our primary home(we did live in it for 2.5 years) to decide whether we want to sell or not without taking a tax hit. As of right now we think we are going to keep the house long term. It’s in the city, good neighborhood, nice home.

So now taxes. We started renting the home at the end of July. Before we rented it, we actually made some investments in the home. Again job offer came out of the blue, so we had saved up money to make some improvements in the home. We spent $5K installing new HVAC in April and $4K installing new windows and sliding door for the backyard.

Question-

  1. How do I treat the expenses we made prior to renting the house?
  2. I read somewhere about establishing the market price of the house and log it in the books. Anyone understand this topic? Potentially could explain a bit more.
  3. Depreciation - Should I start taking depreciation?

I would really appreciate thoughts from people have gone from owning their primary home and renting it.

Thank you!


#2

[quote=“savvyfinanciallatina, post:1, topic:1763”]

  1. How do I treat the expenses we made prior to renting the house? [/quote]

All of those additions get added to your cost basis. Land is not depreciated btw, only structure. Your property tax bill from your county may have a land number and structure number. There are other ways to calculate it. I don’t know off the top of my head though.

[quote]
2. I read somewhere about establishing the market price of the house and log it in the books. Anyone understand this topic? Potentially could explain a bit more.[/quote]

That’s only something you need to be concerned with if your property has gone down in value since you purchahed. It’s the lesser of the two. If it’s gone up (which I imagine it would have if your talking about selling for gains without paying taxes), then your cost basis is your purchase price plus any adjustments for additions. See answer to first question.

However, you are required to rent out your property for at least a fair market value rate. It’s mostly nebulous but basically the idea is you can’t say, rent out a house to your parents for $10 a month and deduct all the losses against your taxes. If you are trying to rent for profit (or at least a reasonable number, that couldn’t be argued that it wasn’t for profit, you’re fine.)

You should be able to determine fair market rent value just be googling around your area…

Yes, because whether you take it or not, the IRS assumes you did take it when you sell and you will owe the “recapture taxes” on it even if you didn’t take it. So there’s no reason not to take it.

TurboTax Premier will save you a ton of time on tax prep.


#3

I am actually using Turbo Tax Premier but wanted to get additional input. Thanks for the fast response.

  1. So do I need to establish the cost basis now? Or make sure to keep all the receipts for everything (which I have been doing) so when I sell down the road?

  2. Yes, the home has appreciated. We bought the house for $134.5K in 2013 and when we talked to the realtor, the home had appreciated to $175-179K. We are renting at a fair market value.

  3. Had no idea the IRS assumed you took depreciation. That’s super interesting!!! Recapture taxes? Even if we sell the home within the 3 year limit?


#4

Yes, because your depreciation is calculated from the adjusted cost basis on the day you converted it from a personal asset to a rental asset. If my memory is correct, that would be your purchase price + closing costs rfom the purchase + these improvements. IIRC, any future improvements would be depreciated as it’s own line item.

Yes, you are just paying back the depreciation you took (or were expected tot take). The kicker is the depreciation is recaptured at, I believe, a minimum rate of 25%, so in my case, I was in a low income year the two years that I rented my property out, so I actually paid the depreciation back at a higher rate than when I took the deduction.


#5

Thanks TJ! Very useful information.


#6

No problem! I invested many hours of reading the IRS publications and I was still confused. Might as well save everyone else all the extra time whenever I can!


#7

Yes, I was going doing the same. Reading IRS publications, it was confusing me :slight_smile: