Tax/Mortgage Consequences Of Personal Residence To Rental

Hi, First Post here!

Just got married last year (terrible tax consequences!), and my husband I bought a duplex this year in HIS name as a personal residence. (The reason we bought it in his name is because I co-own another property and wanted to keep my options open to buy more of that building by keeping my debt low, and we could afford to do it in just his name).

1. We are now thinking about keeping the duplex as a rental (as the rents far exceed the expenses due to our low offer) - but how do we file our taxes for this income next year? Schedule E, C-EZ (MFJ) or should we make a LLC? Should we be refinancing it to make the income equal the outgoings, and pull cash out?

2. If you make over 150k (easily done and doesn't go far in the bay area), does this mean the 'passive' income gets added to wages/self employment income? What are the best tax strategies?

3. What are the rules on informing the mortgage lender you want to change the loan to a rental? Is it easily granted? (My husband does not own any other properties)

Confused -Thanks.

Congratulations on what sounds like a very good deal. Input is as follows (from a fellow Bay Area person):

1) In your initial year as a rental, you will report the time it was your personal residence as expenses that can be itemized on Sch. A. When you convert it to a rental, those expenses should be reported on Sch E. So in the initial year, you'll need to break out the expenses between personal and business (rental). Once it becomes a rental you will need to start depreciating the property which you can take as an expense on Sch E (land is not depreciable BTW). As to refinancing the place, that's a personal preference, however if you know it will be used as a rental you should disclose that to the lender. Unfortunately, lenders charge higher rates and require more down for rental properties, so weigh the pros/cons of the refi. carefully.
2) Your rental income will be added to your other income and appear on page 1 of your 1040 as taxable income. As long as your rental produces income (after expenses INCLUDING depreciation), you don't have to worry about income limitations affecting your rental (that only comes into play when you have a rental loss).
3You don't need to inform the lender on this. You bought it as a principal residence and now have decided to treat it as a rental. You will need to change your homeowners insurance policy to a landlords policy.

You may already know this since you have other rentals, but I'd strongly recommend you consider getting a landlord book from Nolo press called: Every Landlords Legal Guide. If your property is in CA, they have one specific for CA (available from your local librabry, bookstore or www.nolo.com. These books have saved me a lot of grief over the years. The most important step in being a landlord is screening carefully in my opinion. I have never had an eviction. I believe its because I was patient and screened carefully. I can't tell you the number of "nice" people who I would have rented to just based on the one on one conversation...but after the full screening (income, employment, credit and past landlord verification) I had to reject them. Screen carefully (but fairly), you won't be sorry.

Thanks so much for the quick reply. I have the nolo book and found it to be a great reference. I just turned my residence into a rental when we bought the duplex, now I am feeling overwhelmed with options and tax implications.

1. So, if we agree to have 50/50 ownership of the duplex, because its in my husbands name we will file a Sched E and not C-EZ (MFJ), because he will be receiving the 1099’s? (…. we will be writing up a partnership/other agreement once I know what we should be doing).

I am an architect, and just remodeled the duplex and have increased the ‘value’, I was wondering if we should refi it and pull money out to make our taxable income less when we rent it, and to do some more work? Do I get any tax break for doing the work…or how can I compensate myself? If we earn above 150k, we are limited to our deductions right (AMT)?

2. Don’t we want a rental loss: because overtime the rents will increase and we’ll be paying more taxes?

Do you have any tips for other places I should be doing research?

1. So, if we agree to have 50/50 ownership of the duplex, because its in my husbands name we will file a Sched E and not C-EZ (MFJ), because he will be receiving the 1099’s? (…. we will be writing up a partnership/other agreement once I know what we should be doing).

As a general rule, the income and expenses from rental property you own personally is reported on Schedule E. Whether the property is sole owned or jointly owned, you still report rental income and expenses on Schedule E -- even if you file a joint tax return.

If you and your husband form a legal partnership, perhaps an LLC treated as a partnership, then transfer title to the property to this partnership, the partnership will report the rental income on a partnership tax return (Form 1065) and the partnership income will still be taxed on your personal 1040.

Whether you decide to form a partnership is not a tax issue, but a legal issue. Consult your attorney and estate planner for specific advice.


I am an architect, and just remodeled the duplex and have increased the ‘value’, I was wondering if we should refi it and pull money out to make our taxable income less when we rent it, and to do some more work? Do I get any tax break for doing the work…or how can I compensate myself? If we earn above 150k, we are limited to our deductions right (AMT)?

Refinancing is a personal decision. Understand that to reduce your taxable income, you have to spend money. Reducing your taxable rental income by $1000 means that you have added $1000 to your expenses.

If you are in the 25% tax bracket, that $1000 in rental income will add $250 tax to your tax bill. You still have $750 in your pocket after taxes. Increasing your expenses by $1000 will reduce your tax bill by $250 but it will cost you $1000 to do so.

Would you rather have $750 in your pocket after taxes, or spend $1000 to save $250? I said, refinancing is a personal sion to refinance is a personal decision, just make sure that doing it makes good business sense.


2. Don’t we want a rental loss: because overtime the rents will increase and we’ll be paying more taxes?

What is wrong with paying more taxes? Paying more taxes is just a consequence of making a lot more money. Expenses that are reasonable and prudent can reduce your taxable income and therefore your tax liability. But, to go out of your way to spend money just to lower your tax bill is usually more expensive in the long run than just paying the taxes.

You should look forward to the day when your tax bill is $1 million. When that happens, your total income will probably exceed $3 million. I would much rather pay the $1 million tax bill and have $2 million in my pocket after taxes, then spend $3 million just so I won't have a tax bill.


[ Edited by NewKidInTown3 on Date 04/10/2008 ]

A Clarification for Clara-

A refi in and of itself will not increase your expenses (beyond the loan cost, of course!). Although you will be paying more interest on the higher loan amount, only the portion of the interest paid for the money that went into the property is deductable from your rental income. The interest paid on the cash you pull out, if that cash is spent on something other than improving the property, is not deductable.

Chris