Author Topic: Seeking advice: tax implications for renting out our primary home for a cpl yrs?  (Read 1603 times)

CloserToFree

  • Bristles
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  • Location: Major U.S. City
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I'm a complete novice on real estate issues and would love reactions from you experts about our situation.  We're considering moving abroad for a couple of years and renting out our home while we're away (idea being maybe we can at least partially live off the rental income).  Rough facts/assumptions are below but we're not sure it's really worth it given that we hope to return to our home and live there semi-permanently.  And I'm having a hard time figuring out what the tax implications of doing this would be -- not sure if we could deduct mortgage interest come tax time, and don't think (??) conversion into a rental property would make sense given our plans to return and live in the house (but I confess I am fairly ignorant about what this means).  I've been looking through various IRS pages and googling around about applicable deductions but it seems most guidance is not geared to our situation (renting out our primary residence vs. renting out other rental properties we own but have never lived in, or renting out a vacation property), so it's confusing.  My husband's gut reaction is that it wouldn't be worth it at the end of the day, but I'm a little more hopeful.

What I want to know is: (1) how much (if any) U.S. federal income tax would we owe on the rental income, assuming this is our only income? and (2) how much cash would we net after taxes, operating costs, etc. (which we could then use to help fund our living expenses abroad)?  Could anyone point me in the right direction for figuring this out, and/or offer informed thoughts?

Home value: 800,000 (about half paid off)
Remaining mortgage: 400,000
Our monthly mortgage payment (including mortgage interest - about 14,000/yr; property taxes - about 8,000/yr; insurance - about 1,500/yr): 2,700 (x 12 = 32,400 yearly)
Expected rent: 4,000/mo; 48,000/yr

Let me know if I'm leaving out any critical information here.  Thanks very much!

Spitfire

  • Bristles
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  • Location: Weston, FL
If you aren't living there, it isn't your primary residence anymore. The most common deductions from your rental income would be:

Mortgage Interest (not principal)
Insurance
Property Taxes
Management Fees (if you pay someone to manage it while you're gone)
Maintenance/Repairs
Depreciation on the cost basis of your property (not fair market value). This will be the purchase price plus certain closing costs and major improvements. Divide that total by 27.5 for your yearly deduction.

That should be a reasonable start to estimate what you're looking at for taxable income.

If your husband doesn't think it's worth it, what's the alternative? Letting it sit unoccupied and miss out on 48k of income?

CloserToFree

  • Bristles
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  • 30-sth lawyer (for now), traveler, lover of nature
Thanks so much, Spitfire.  Yeah, my husband's feeling is that if (after taxes, costs etc) we'd only walk away with something like $10k, then it may not be worth the hassle of finding good tenants, the wear and tear, and potential complication of the status of our house vis-a-vis the capital gains exclusion.  (While I think it's crazy to forego even $10k.) On the cap gains point, and re your mention of taking depreciation deduction-- would that prevent us from being able to take our full capital gains exclusion if we decided to sell the house after we rent it out for say 2 years?  The initial facts I provided were a little simplified in that we bought the house a few years ago for around $800k, and it's now worth something closer to $1m.  So we'd want to make sure we don't mess up our ability to exclude the $200k+ of gain if/when we decide to sell it.  Any thoughts on that?

Rubic

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I was about to respond to the question with some opinions I've been
formulating (and acted upon), but I thought it might be more interesting
to solicit information in the form of a poll:

 http://forum.mrmoneymustache.com/real-estate-and-landlording/how-many-of-you-have-returned-to-live-in-your-home-after-renting-it-out/

Spitfire

  • Bristles
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  • Location: Weston, FL
If you sell the house after renting for 2 years, you will still get the exclusion, since it would be your primary residence at least 2 of the previous 5 years. However, you would have to pay tax on any depreciation you deducted at ordinary rates. 

If you move back in after 2 years, you will get a partial exclusion when you sell it. If, for example, you sell it when you've owned it for 12 years and you lived in it for 10 and rented it for 2, you could exclude 10/12 of your capital gain. You would also pay tax on the depreciation in this scenario too.

CloserToFree

  • Bristles
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Thanks so much.  In the first scenario, would we get the full exclusion? Or also only a partial one? (Wondering why moving back in results in a sort of penalty, if indeed we could take the full exclusion if we sold immediately after renting it).

Spitfire

  • Bristles
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You would get the full exclusion in the first scenario.

They made that rule to stop people from moving into rental properties every 2 years in order to exclude the full gains. I think it was to target people with multiple properties who want to liquidate over time while avoiding tax, but unfortunately it would get your second situation also.