Building rental unit - what's tax deductible?

[FIKris]

Hello MMM community,

I'm building an addition and turning my property into a duplex (lot is zoned for multifamily) in order to create a solid retirement income stream.  I have some experience owning and managing rentals before and am familiar with the tax basics for landlords, however, handling taxes for a newly constructed rental is new to me.  If I build with cash instead of a construction loan, is the cash I spend to build the rental tax-deductible?  Could I use it to offset income from my day job?

I do plan to consult a tax advisor, but wanted to start here since I respect the knowledge that many of you folks have accumulated over the years.

[FIKris]

Update: standard depreciation won't be of much help - we anticipate $2k/month ($24,000 per year) of rental income starting in 2024, with minimal income from other sources.  We'll be living off rental income and savings that have already been taxed.

After the standard deduction for married filing jointly, our income will be somewhere between $0 - $10,000, so we'll only be in the 10% tax bracket, if we owe at all.  Not sure if it makes sense to claim depreciation for the duplex unit in this scenario; I'm worried it'll expose us to depreciation recapture or complicate taxes in the event we sell the property down the road. 

[sailinlight]

You have to repay any depreciation you could have deducted. So not deducting is not smart. Amortize the cost of building the second unit over 27.5 years and deduct that from your schedule E every year even if it's unallowable. You can deduct it when you sell later, or make a profit at some time in the future.

[FIKris]

You have to repay any depreciation you could have deducted. So not deducting is not smart.

Woah!  So even if you don't take depreciation, the IRS makes you "repay" it anyway?  Crazy.  Thanks for the heads up. 

[Sibley]

If you spend $50k to build it, you will add the unit to the depreciation schedule with a cost of $50k. Then you will depreciate the $50k over 27.5 years on the Sch E.

Each year, you will file a sch E as part of your taxes. You will report your rental income and expenses, including deprecation expense. The net profit or loss is then carried to the 1040.

In the future, when you sell the property, you will be taxed on your gain + the deprecation that you have taken.

None of this is optional. Comply, or the IRS can rake you over the coals.