Rent or not ... our other house

[funky]

What is the name of your state? FL

Hello,

I am utterly confused as to the tax implications of our situation. My wife and I purchased a house in Florida in May 2005, and have made 30% on this house already. We have decided to purchase a 2nd home in the same area. To do this, we are using the 1st home's equity line for 10% down payment.

The question is, should we rent this house out after we move?

Here are some details:

combined gross income: 156k / yr

1st home mortgage: 205k
1st home equity line: 130k (50k for 1st home + 80k for 2nd home)
1st home value: 360k
2nd home mortgage: 516k
2nd home equity line: 64.5k
2nd home value: 645k

1st home mortgage interest: 9k / yr
1st home equity line interest: 9.8k / yr (3.6k for 1st home + 6.2k for 2nd home)
2nd home mortgage interest: 21k / yr
2nd home equity line interest: 5k / yr

rental income would be: 14-16k / yr
rental expenses would be: 2.6k / yr
rental property taxes & insurance: 3.5k / yr


help! I don't quite understand the tax implications .. i am very good at math, but the tax code seems a bit confusing about our situation. would we lose out more if we turned this into a rental property? is it a 2nd home since it is less than a mile from our primary residence?

thank you soooo much!!

 

[abezon]

It's a rental if you rent it out at fair market value. Is renting is a good idea? You'll have to talk to a financial advisor about your cash flow needs and what kind of investment diversification you want. A general rule of thumb for income-producing rental properties is that you want to get 1% of the purchase price as the monthly rent. This will cover the mortgage & taxes. You usually run at a slight profit cash-wise, & at a loss for tax purposes, since you get to claim depreciation (if you want to). 30 strangers buy you a house.

An alternative rule is to look at how much you'll have to kick in each month to make up the rent/mortgage shortfall. Then ask, if you could buy this house for that amount of money every month, would you do so? Be careful to include all expenses -- mortgage, taxes, insurance, maintenance, and savings for repairs and months the house is empty when you'll have to cover the mortgage in full. If the real estate market is still going strong, keeping the place is a good idea. If things slow down, you might want to sell then, since your return on investment will be lower. With this scenario, you're betting that the house will appreciate faster than other types of assets, like stocks.

Most taxpayers get to deduct rental losses. However, with AGI over $150,000, you won't be able to deduct any losses. Instead, you'll carry them forward & deduct them in the year you sell the place.

In any case, I strongly recommend you keep the house for at least a year before selling, so your capital gain is long term. That way your tax on the profits is 15% instead of 28%.

 

[funky]

misunderstood me...

Perhaps I was not clear. My question was concerning the tax laws for deducting mortgage interest.

Which way will we make more money, renting it out or not? On the surface it seems an easy question, but by renting, I think we lose alot of our mortgage interest deduction? And that might end up costing us more in tax dollars.

 

[Snipes5]

Your mortgage is still deductible if you are renting it out, it just goes in a different place on your return.

The only way you "lose" on a rental is if it is unrented, or your renters trash it. Otherwise you have people paying your mortgage for you while you sleep, building equity in the property, AND you get a reduction in taxes because of the loss on your return.

See a financial planner AND a tax preparer for the details.

Snipes

 

[funky]

doesn't the place where you make a deduction make a huge difference? schedule a (home mortgage interest deduction) lowers your AGI, whereas schedule c/e (rental mortgage interest deduction) would only lower business income and only to a certain amount (-3k / yr ?).

i will seek professional advice -- just thought i could get it here!

 

[Snipes5]

$3000 allowable loss applies to capital losses, not rental losses. The limit on rental losses is $25,000 per year.

A capital loss is when you sell a capital asset, such as a painting, stocks, bonds, or a rental house, at a loss.

Also, if you take a close look at the front page of a form 1040, you will notice that in the top section where income is listed, the amounts are added together, adjustments are subtracted, and that is how you arrive at AGI.

Itemized deductions lower your taxable income. Rental losses lower your AGI.

Snipes

 

[abezon]

Schedule D losses are limited to $3000/year. Losses on Sch.C are nearly unlimited. On Schedule E, your "loss" will be limited to $0 because of your high AGI. However, you'll still come out ahead.

If you don't rent the place, you'll pay $25,000/year in mortgage & taxes & insurance/maintenance. You can use the house whenever you like, but you get no income. You can deduct on Sch.A the mortgage interest & property taxes. Other expenses are not deductible.

If you rent, you still have $25,000/year of expenses, but you'll have $15,000 of income. You can deduct the expenses to bring your net income down to $0 and carry the rest forward.

Not being able to deduct the ~$19,000 of interest & property taxes will cost you about $4,000 in taxes, but you're getting $15,000 in income, so you're $11,000 ahead each year. Plus, when you finally sell, you'll have a large terminal loss which *will* be deductible regardless of your AGI and will save you lots of tax money then.