$250K Cap. Gains Exclusion On Primary/rental Property?
I understand that the $250K capital gains exclusion is supposed to apply strictly to property that I own and use as my primary residence. But what if I do this, and also rent out a room or two in the house? It is still my primary residence, it just also happens to be rental property. Can I still qualify for the capital gains exclusion? What about some of the tax benefits of owning rental property, like depreciation?
Thanks!
If you use part of your primary residence for a home office, or, rent out a room for more than 14 days during the year, your property is now a mixed use property.
Part of your property is your residence and part is your investment/business property. When you do your tax returns, you allocate the portion of the property to your investment/business use, perhaps using a square footage approach. Next using the square footage of the investment/business portion, calculate what percentage this is of the total property.
You may deduct this percentage of your mortgage interest, your homeowners insurance, and your utility bills, against the business/investment income on your tax return. Use this percentage of your cost basis to compute your basis for depreciation (remember, land can not be depreciated).
When you sell the property, this percentage of the profits is also your taxable capital gain from the sale of your business or investment property. Depreciation recapture will still apply. The rest of the sale profits are eligible for exclusion from capital gains if the two year rules are met.
Can't I deduct the mortgage interest whether it is investment property or owner-occupied? Therefore, wouldn't I be able to deduct the entire amount of mortgage interest from my income, not just the portion set aside as being for investment?
Yes you do deduct the entire amount of your mortgage interest, but you do it in parts.
The amount of mortgage interest allocated to your residence use is deducted on Schedule A if you itemize your deductions.
The amount of mortgage interest allocated to your investment/business use is reported on Schedule E. Schedule E is where you report your rental income and offset that income with your operating expenses (including mortgage interest) and also claim your depreciation expense.
Got it. I actually thought that might have been what you meant, but I just wanted to be 100% certain.
This kind of leads to another question... since taxes can get quite complicated when getting into real estate, how many people do it themselves? Do most recommend getting the help of a tax professional? How much do these services usually run?
Thanks!
I have always done my own tax returns, and Tax Preparation software (I use TurboTax) has certainly made the job easier.
If you are not comfortable doing your own tax return, I have known people to pay a professional accountant up to $500 to do a return. This was back in the early 90s before sophisticated tax preparation sofware became available.
I believe H&R Block bases their fee on the number of forms and schedules prepared for your return. You have to shop your local tax preparers and compare their fee structures.
Also ask if they make a mistake, will they pay any penalties and interest you may be assessed, and,
if you are audited, will they accompany you to the audit to explain how your return was prepared and argue in your favor.