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Seek Advice re "2nd Home" to "Rental House" Transition
Old 04-23-2010, 12:15 AM   #1
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Seek Advice re "2nd Home" to "Rental House" Transition

We own a house a few hours from our primary residence and currently claim it as a "second home" for tax and insurance purposes. As our need to live in the second house for my wife's business purposes have decrease gradually over a period of a couple years to almost zero, I have been increasingly investing significant materials, labor and travel expenses into fixing it up solely for the purpose of renting it out.

Now I want to hire one hourly employee as my assistant while doing these improvements to speed the process to its end. I have someone in mind but hesitate to proceed until obtaining clarity on my choices of how to structure the business aspect (a few hours at the irs.gov page has me somewhat unsettled).

Questions:
1) Do I have to somehow legally form a business or otherwise declare my intention to rent the house in order to eventually deduct improvement expenses, say, possibly by changing from home owner insurance to rental insurance?

2) I have records and receipts of my labor, materials and travel expenses for the past two years. Is there a way to deduct these against future rental income?

3) The employee I want to hire would only be working for me at the one house, and would be covered under my home owner insurance (I donít know about worker coverage under rental insurance...). If I pay him as a "household employee", would this expense be deductible against future rental income?

4) What business structure is most often used in the case of one rental house, that may increase to two or three over a two or three year period? We plan to divide our main residence lot in half and build a new house there, then rent all three houses, put them with property managers, and move onto a sailboat.

5) Is there a good standard reference piece on this somewhere so I could avoid being tempted to make long & dull posts like this?

Glad to hear any comments, thoughts, advice or smart remarks.
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Old 04-23-2010, 11:31 AM   #2
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Given your long-term plan, I think you need to consult a tax lawyer/accountant. What you do now may impact what you want to do then.

(IANAL but I don't think you can recast expenses already spent on a second home.)
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Old 04-23-2010, 10:02 PM   #3
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Quote:
Originally Posted by Bonden View Post
We own a house a few hours from our primary residence and currently claim it as a "second home" for tax and insurance purposes. As our need to live in the second house for my wife's business purposes have decrease gradually over a period of a couple years to almost zero, I have been increasingly investing significant materials, labor and travel expenses into fixing it up solely for the purpose of renting it out.
Since you have not yet advertised it for rent, it is not a rental property. All you have been doing to date are either capital improvements or repairs. As a personal residence, repairs are not deductible and do not contribute to the basis cost of the house. Capital improvements, at this point contribute to the basis cost of the house. Your labor, at this point has no tax significance. As far as IRS is concerned, its free labor.

Quote:
Originally Posted by Bonden View Post
1) Do I have to somehow legally form a business or otherwise declare my intention to rent the house in order to eventually deduct improvement expenses, say, possibly by changing from home owner insurance to rental insurance?
Nope. You just advertise it for rent and rent it out. No special business license or business formation such as corp.,LLC, etc is needed. In fact if you did form a special business to own the property and transferred property title to that business, the lender could demand you pay the loan off (ie accelerate your loan). You declare you intention to rent by making it available for rent and advertising it for rent. Of course as soon as this becomes available to rent, you change insurance from a home owners policy to a cheaper fire policy ( rental policy). Be sure and get lots of liability insurance for when renters sue you.
Your improvement expenses, at best, increase the basis cost of the property, and when you account for the rental on Sch. E, you get to depreciate the improvements.

Quote:
Originally Posted by Bonden View Post
2) I have records and receipts of my labor, materials and travel expenses for the past two years.
These are nice, but until this is advertised for rent, it is persanal property not rental business property and your labor is free. Until this becomes a business, the travel expenses and materials can at best be included in the capital cost of the property and at worst not be applicable at all. It depends of what it was for.

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Originally Posted by Bonden View Post
Is there a way to deduct these against future rental income?
Only via a basis cost increase, until this becomes a business.

Quote:
Originally Posted by Bonden View Post
3) The employee I want to hire
Do you really want an employee? If so you'll have to pay FICA, Medicare, Unemployee Insurance, Employee Site Insurance, as well as file with the state & fed every 3 months. Think really really really hard about the designation of "employee".

Quote:
Originally Posted by Bonden View Post
would only be working for me at the one house, and would be covered under my home owner insurance
This is only accident insurance for a non-employee, sporatically working on your property.

Quote:
Originally Posted by Bonden View Post
(I donít know about worker coverage under rental insurance...).
Check with your insurance agent, I don't believe that person would be covered under home owners, but would be under the liability section.

Quote:
Originally Posted by Bonden View Post
If I pay him as a "household employee", would this expense be deductible against future rental income?
Nope. Not until it becomes a business.

Quote:
Originally Posted by Bonden View Post
4) What business structure is most often used in the case of one rental house, that may increase to two or three over a two or three year period?
Just a personally owned rental house. No corp., LLC etc. Unless you want to dramatically increase your expenses and paperwork by hiring attorneys, cpa's, property managers, accountants etc.

Quote:
Originally Posted by Bonden View Post
We plan to divide our main residence lot in half and build a new house there, then rent all three houses, put them with property managers, and move onto a sailboat.
Best of luck with this plan. Better check that zoneing allows this, that you've the cash to build and that the final result cash flows.

Quote:
Originally Posted by Bonden View Post
5) Is there a good standard reference piece on this somewhere so I could avoid being tempted to make long & dull posts like this?
try the website: bbs2 . mrlandlord . com
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Old 05-18-2010, 10:32 AM   #4
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Provided you generate rental income this year, your accountant should allow you to take this years improvements against those rents. It's an easy way to bury the rental income. Declare too many improvements against too little rental income and you'll have the IRS banging on your door.

Consider a local contractor and or property manager to do the dirty work. No need to "hire an employee".

Have you considered renting as a vacation rental? This would allow you to use the property when you need it and bring in some rental income to carry the property. IRS will only allow 2 weeks for personal use (but "working" at the property doesn't count ... I'll be spending the weekend at the lake "working" - mowing the lawn). Check VRBO.com or Homeaway.com for competing vacation rentals in your area. It'll help determine viability and pricing.

Don't over improve if you're renting out. Fresh paint and steam cleaned carpets should be enough if it was good enough for you (before).

A common trend is put each property in an LLC. Really no need for this with the first one. Just make sure you have Liability coverage and an umbrella policy (if you REALLY want to cover you rear). You get up around 6 and umbreallas are not available then you need some other structure (S corp, LLC ... ).
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