Reporting taxes and income on primary/rental property

[dragonwalker]

I am looking at purchasing a condo soon as a first time home buyer. It's going to be a 2 bed, 2 bath unit. I am looking to rent 1 room and live in the other. I anticipate I would get about $1000 per month. Let's say I get 11 months of rent per year so $11K gross. Can someone explain to me what my tax liability on this rental income would be if the following were true.

Monthly PI: $930
HOA/mth: $406
Property tax avg. per month: 343
Utilities: 100
Insurance: 50

I have read that one way is to literally split my expenses in half and I would be able to deduct them? Excluding HOA, however I have heard that I may be able to because any tenant I have would be able to enjoy the full benefits of the HOA including access to common spaces and parking etc. If I didn't include the HOA and split half of all the other expenses and deduct it from $11K gross rental I get a figure of about $3K net. Could that be my taxable income at my marginal tax rate?

The other thing is my interest rate is exceptionally low due to company incentive interest rate so my interest expense, property tax would definitely not exceed my standard deduction but would these rental deductions add to that or is it one or the other meaning either I take the standard and no deductions or I can itemize everything.

[secondcor521]

"You don’t have to divide the expenses that belong only to the rental part of your property.  For example, if you paint a room that you rent or pay premiums for liability insurance in connection with renting a room in your home, your entire cost is a rental expense. If you install a second phone line strictly for your tenant's use, all the cost of the second line is deductible as a rental expense. You can deduct depreciation on the part of the house used for rental purposes as well as on the furniture and equipment you use for rental purposes.

How to divide expenses. If an expense is for both rental use and personal use, such as mortgage interest or heat for the entire house, you must divide the expense between rental use and personal use. You can use any reasonable
method for dividing the expense. It may be reasonable to divide the cost of some items (for example, water) based on the number of people using them. The two most common methods for dividing an expense are (1) the number of
rooms in your home, and (2) the square footage of your home."

-- https://www.irs.gov/pub/irs-prior/p527--2019.pdf page 16.

The above instructions talk about depreciation.  Depreciation is a little bit complicated, but basically you can allocate a portion of the value of your home to the rental and then subtract some of that value each year as a depreciation expense.  When you go to sell the home, you have to recapture that depreciation (i.e., pay taxes on it) whether you took it or not.  See chapter 2 at the above link starting on page 4.

Since you're dealing with a 2/2, then by method (1) above it appears you could use the "divide in half" method.  (This would not be true if you had a 3/2; you'd either have to do 1/3 or 2/3 depending on how many rooms you were renting out.)

You or your tax preparer will report your rental income and expenses on schedule E.

[soulpatchmike]

With those numbers and a 50% rental use, add in depreciation(which you are required to do with the schedule e per IRS rules) and you will likely have a net LOSS on your schedule e of about $2000-2500, assuming a purchase price of about $150k due to depreciation.  Basically, it becomes a deduction on the income side of your tax return lowering your AGI.  This is one of the many benefits of rental real estate.  All expenses are deductable so that $1000/mo quickly becomes theoretically only about $100/mo "profit" of which depreciation takes care of the reset.  Four ways of making money with rentals, cash flow, principle paydown, tax benefit(depreciation) and appreciation(assuming you sell at a profit)

One consideration, you will have to do a depreciation recapture when you sell.  One way to limit capital gains tax on half of the gain if you sell in the future would be to occupy it fully(without renter) for 2 out of the last 5 years.  But no matter what, you will have recapture tax for any depreciation required for the rental, whether you took it as a deduction on your schedule e or not.

I am not a tax pro, just a landlord for the past 22 years.  Last year I collected about $60k in rent, but my schedule e stilll shows a small loss against my rent collected based on expenses and depreciation, however my net cashflow was about $15k.  Effectively zero tax liability on the income, however, depreciation is a great thing at tax time but a rough thing when its time to sell due to depreciation recapture tax.