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real estate purchase and tax implications question
Old 02-13-2005, 11:15 AM   #1
 
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real estate purchase and tax implications question

We are just about to close on a small property. It is old and tiny but in an excellent location. The house is not worth much, it is all in the land. We got a good deal because we offered cash.

The plan with this small house is to rent it out for the next year. We will then use it as our homestead for another two years and sell our current house. Once we have enough cash, we will knock the whole thing down and have something decent build on it.

To finance this thing, we took a $108K home equity loan. This was less hassle than a mortgage, did not cost any fees/points and the interest was ok. I know this home equity line interest can be used as an itemized tax deduction but we usually barely go over that treshold.

Is there a way that the home equity loan interest can be used as an above-the-line deduction since we will be receiving rental income from the property for a year? Once we move in there ourselves, our current residence against we took the home equity loan will be paid off.

Does anybody have any experience with this?

Vicky
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Re: real estate purchase and tax implications ques
Old 02-13-2005, 11:41 AM   #2
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Re: real estate purchase and tax implications ques

The interest may not be deductible at all, as the HELOC usually needs to be used on a first or second home, or expenses related to that home. If you're renting the property, its not a first or second home. Check with your tax expert or the IRS web site for your specific scenario.

There are a raft of expenses you can deduct on a rental property, including mortgage interest (but maybe not heloc interest), costs associated with renting, managing and maintaining the property, and depreciation. For a very short term rental period though a lot of these may not be hugely beneficial. Especially if you knock the house down instead of selling it or moving into it.
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Re: real estate purchase and tax implications ques
Old 02-13-2005, 03:33 PM   #3
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Re: real estate purchase and tax implications ques

This is a whacko tip and may not apply in your situation, but if you're planning to demolish a house you own, consider donating it to your local fire department for "structure fire training."

The volunteer department I used to serve with would accept your donation, write you a nice letter for the IRS, come out, set your house on fire, put it out, set it on fire, put it out, etc., until the house was gone.

End results: a tax deduction and an empty lot.

Your mileage may vary.

Ed
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Old 02-13-2005, 06:29 PM   #4
 
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Re: real estate purchase and tax implications ques

I like that idea, I just can't see it happening. The neighbor is 10 ft away. I am sure they don't want to be part of the donation
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Old 02-13-2005, 07:24 PM   #5
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Re: real estate purchase and tax implications ques

Also, watch the zoning.

In my brother's case if the house is demolished the land must be multi-family or town houses.
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Old 02-14-2005, 10:13 AM   #6
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Re: real estate purchase and tax implications ques

Vicky,
If I understand, you took out a HEL on your principle residence to pay for this house. As long as the new (well, to you) house is used as a rental, you can deduct the interest on Schedule E directly against your rental income (an above the line deduction). This will yield a much better result than deducting it on Sch A (itemized deductions).

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Old 02-14-2005, 04:51 PM   #7
 
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Re: real estate purchase and tax implications ques

thanks beachbumz!

I will do it that way. Do I need a special form from the bank that says I have used my HELOC for the rental?

I hope doing some basic (tax-deductible) repairs and then renting it out for just a limited time (year or so) before we move in is ok. Like to write off as much as possible without getting into trouble with uncle sam
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Old 02-14-2005, 05:22 PM   #8
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Re: real estate purchase and tax implications ques

vicky,

You can charge off depreciation as long as you
rent the property, but keep good records. You
will need to adjust the tax basis if you sell before
living in it.

I don't know how the tax exemption is handled
on property that you once claimed depreciation.
You might want to check this out.

Cheers,

Charlie
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Old 02-14-2005, 09:42 PM   #9
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Re: real estate purchase and tax implications ques

You can depreciate the PROPERTY, but don't try to depreciate the LAND that it sits on.

The IRS loves auditing this one...
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Old 02-15-2005, 06:47 AM   #10
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Re: real estate purchase and tax implications ques

Quote:
thanks beachbumz!

I will do it that way. Do I need a special form from the bank that says I have used my HELOC for the rental?

I hope doing some basic (tax-deductible) repairs and then renting it out for just a limited time (year or so) before we move in is ok. Like to write off as much as possible without getting into trouble with uncle sam
Vicky,
No, there is no special form to get. The interest will be reported to the IRS and you on form 1098. It is up to you to deduct it in the right place. If you were audited, then you would have to show the IRS proof that the money was used for the rental property.

You may want to go to www.irs.gov. There is a lot of information there on how to handle rental property.

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Old 02-15-2005, 07:50 AM   #11
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Re: real estate purchase and tax implications ques

Quote:
vicky,

You can charge off depreciation as long as you
rent the property, but keep good records. You
will need to adjust the tax basis if you sell before
living in it.

I don't know how the tax exemption is handled
on property that you once claimed depreciation.
You might want to check this out.

Cheers,

Charlie

Two comments: First, be sure to claim the depreciation. The way it works is that you must deduct the greater of any depreciation claimed or that you were eligible to claim from the basis when you sell it.

I believe there is a seperate way to enter gain due to depreciation when you sell it, and you get taxed on that at ordinary rates, but as Charlie says, check the tax guides or with your accountant to be sure.

Wayne
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