Have you ever rented your primary residence to somebody?

[Peaceful_Warrior]

Your response is more along the lines of what I was trying to get at. I understood what you said about 'Active' since I read that IRS pub, but wasn't sure how that fit into the grand scheme of things.

Thanks for pointing out the depreciation recapture... that's something I didn't understand and will look into. From what I've just now read, it sounds like in my case, it means that I would get a tax-free gain on everything I *should* have gotten, but if I depreciated anything then I have to pay taxes on whatever gains I have as a result of the depreciation.

Overly simplistic example here:
- Cost basis is $350k
- Depreciated $25k over 2 years
- Sell as a homeowner for $450k

Result: I get $100k tax free, and I pay tax on $25k at capital gains rate (assuming I can't attribute some of the depreciation to the land). Is that correct?

In reading, it looks like the recaptured depreciation is at 25%, so it's more advantageous to take the depreciation during the rental years. My problem is: I have to qualify as 'Active Participant' in order to qualify to take the depreciation since I'll *already* be renting at a 'Loss' of about $150/month based just on expenses/income.

Since the plan is to move to a lower cost of living area, even renting at a loss and not getting any tax relief is financially advantageous as our total housing costs will go down considerably.

Quote:

Originally Posted by Nords You're abusing the vocabulary a little, too. The IRS assumes that whenever you rent a home that you're depreciating the home. (Don't try to depreciate the land!) This depreciation is "recaptured" as personal income when you sell the home. You'll be punished taxed whether you depreciate or not. So yes, every landlord should take depreciation. The definitions of "active", "passive", and "material" make my head hurt. Essentially you can always deduct expenses up to the limits of your rental income. In addition, if you or spouse actively participate (not necessarily materially!) then you can deduct up to $25K in passive rental losses (in excess of the passive rental income) from your other income. Page 3 of IRS Pub 925 says that examples of active participation include approving new tenants, approving rental terms, and approving expenses. You'll probably have that sort of relationship with your manager so you'll probably be an active participant and you'll probably be able to deduct rental losses in excess of income. Perfectly clear, no? Read the pub (and Pub 527 as well) or seek professional advice before proceeding blissfully down this road. Owning the home for at least two of the last five years allows you to escape cap gains taxes up to a $500K limit (even longer if you're in the military) but you'll still have to pay the depreciation recapture. Again read the rules, seek professional advice, blah blah blah.

[Nords]

PW, you're confusing the heck out of us when you mix the word "depreciation" with the word "deduction".

Lemme start over and make it a little plainer.

When you sell your rental property, the IRS requires you to pay depreciation recapture. You don't have a choice. The IRS assumes that you are depreciating the property according to the depreciation rules. You have to pay taxes on the depreciation of the house (or whatever property you're depreciating) and the IRS will calculate it for you if you don't provide the numbers.

So, IMO, there is no choice whether or not to depreciate your property. You will depreciate it. You'll also depreciate it according to the rules in Pub 527 for buildings, carpets, appliances, furniture, etc. There's no "active" or "passive" or "material" when it comes to depreciation. Just follow the rules, the tables, and the formulae. The IRS will use it all against you later so you might as well use it on yourself now.

The deductions are for your expenses. You can just about always deduct rental expenses to the extent of rental income (but I'm sure someone will point out an exception to that glittering generality). If you have passive activity losses in excess of your rental's passive income, then you can generally deduct those passive activity losses against other passive income (for example, rental home #2). But if you actively participate in those passive activity losses then you can start deducting those passive losses against other (non-passive) income.

I can see why this could be confusing.

Your math is correct-- $50K cap gains free of taxes and another $50K depreciation recapture taxed at 25%.

But now I have to go back and look at our own rental property. If you don't make the two-years-out-of-five rule I believe that the cap gains are taxed as income (in whatever bracket that puts you, ouch) and the depreciation recapture is still 25%.

Martha, how 'bout an assist here?

[Peaceful_Warrior]

Quote:

Originally Posted by Nords PW, you're confusing the heck out of us when you mix the word "depreciation" with the word "deduction".

I was under the impression that when you pay taxes annually, the depreciation WAS a deduction. If this is not correct, then I'm turned all around. If it is correct, then I've got concerns.

So the issue I'm concerned with is this:
- If I'm already taking a loss on the property that I can't deduct from my personal income taxes, then this would mean I also cannot deduct that depreciation.

When I go to sell the property... what happens?

[Buckeye]

I think the rules for active participation are pretty loose for rental property. Hiring a property manager doesn't make you passive since you still make decisions about tenants (at least I would stay in that loop), rental rates, upgrades, major repairs, etc. I wouldn't worry about not being able to take the deductions (including the depreciation).

Look at your property tax bill to see how the assessor has your home value divided between land and dwelling. Land does not depreciate so you will subtract the value of the land from your purchase price and only depreciate the value of the dwelling. You don't necessarily have to use the land value stated by the assessor but sometimes it's hard to know a reasonable value for the lot. If you have another way of knowing the value of the lot, use that. You will also use the lesser of the value at purchase or at the time the property went into service. Usually the lesser value is at purchase but you never know nowadays.

[Peaceful_Warrior]

Thanks for the tips, Buckeye. So now to make sure I understand this -- let's assume I take $150/month loss and also depreciate about $8,000 annually. This brings me to a total loss of about $9,800 that I then deduct from my personal income taxes (assuming I'm 'Active').

Then when I go to sell the place as a homeowner (lived in 2 of 5 years), I will pay capital gains taxes on all of the depreciation that I took. So, if I were to take 2 years for $16,000 then I am going to pay taxes on that at capital gains rate.

In the end, the benefit of the depreciation is that I deduct it from my ordinary tax annually and then pay it at capital gains upon sale.

Is my understanding now correct?

And because of that scenario is why the laws were implemented regarding active/passive to ensure that people aren't using real estate losses as only a tax shelter?

Quote:

Originally Posted by Buckeye I think the rules for active participation are pretty loose for rental property. Hiring a property manager doesn't make you passive since you still make decisions about tenants (at least I would stay in that loop), rental rates, upgrades, major repairs, etc. I wouldn't worry about not being able to take the deductions (including the depreciation). Look at your property tax bill to see how the assessor has your home value divided between land and dwelling. Land does not depreciate so you will subtract the value of the land from your purchase price and only depreciate the value of the dwelling. You don't necessarily have to use the land value stated by the assessor but sometimes it's hard to know a reasonable value for the lot. If you have another way of knowing the value of the lot, use that. You will also use the lesser of the value at purchase or at the time the property went into service. Usually the lesser value is at purchase but you never know nowadays.

[Buckeye]

I don't know the actual tax rate of the recaptured depreciation but it's not treated as capital gains. I think the max rate is 25%. The recapture tax rate would be on the $16,000 in your example. I filled out the forms for the sale of residential real estate in my electronic tax program (TaxAct) so I'm not sure what all the calculations were. All I know is that I wrote a big check to Uncle Sam and to CA.

Don't know the motivation for the passive rules. Seems like I was taking the deductions in lower tax bracket years and paid it all back in a high tax bracket year. The state of CA and the federal government definitely got their share when I sold.

[Buckeye]

Do you have a personal referral on the property management company? Tenants are the first things landlords complain about and property managers are the second thing...or maybe it's the other way around.

[Peaceful_Warrior]

I do, fortunately. I posted to a local list and somebody responded with exclamation about their current landlord/property manager, whom also is the manager for a property that this person's mother is in. The referral described the way the property manager handles situations they've come across.

Based on the referral, I spoke with the property manager and felt that it would be a good relationship.

Quote:

Originally Posted by Buckeye Do you have a personal referral on the property management company? Tenants are the first things landlords complain about and property managers are the second thing...or maybe it's the other way around.