If you are considering converting your home to a rental, there are a number of tax issues you need to consider before making a final decision.
What You Should Consider Before Converting Your Home to a Rental
One of the first issues to consider is that by converting your home to a rental, your main home that is, you may give up an opportunity to realize tax-free income. Currently, taxpayers are allowed to exclude $250,000 ($500,000 for married taxpayers filing jointly) of home gain when they sell a home if they owned and occupied the home as a primary residence two of the five years prior to the sale. Once converted, the property is no longer your primary residence, and if you sell it more than three years after the conversion, any gain would no longer qualify for the home gain exclusion and would be fully taxable.
Not all homes will have appreciated in value. We have seen this over the last few years. In some cases, some homes may have declined in value from the time they were purchased. If a primary residence is sold at a loss, that loss is not deductible for tax purposes. This is because losses are never allowed for personal use property.
What About the Declining Value of My Home?
Some homeowners have a mistaken belief. They think that if they convert their home that has declined in value to rental use, they can deduct a loss when they sell the property. This is not the case.
When a residence use to business use, such as a rental, it needs to be appraised by a certified real estate appraiser. This is true for other non-business property. When the property is converted from personal use, that appraised value is the value (basis). It is from that basis a loss is determined when the property is subsequently sold. In other words, any loss attributable to the period it was a personal use property is not allowed.
What About Computing a Gain on My Home?
For purposes of computing gain, the value (basis) from which gain is measured is the original cost of the home plus improvements less any depreciation claimed.
If your decision is to convert the home to a rental, the rental period begins when you actually make the home available for rent.This is generally the date you advertise the property for rent. From this point on the reporting of certain expenses are made. Rental income on Schedule E of the 1040 is also. These include: the depreciation, mortgage interest, property taxes, other taxes, utilities, repairs, advertising and other expenses.
How Does the IRS Look at a Rental Property?
Rentals are considered passive activities. Generally losses from passive activities can only offset gains from passive activities. However, there is a special rule that allows up to $25,000 of losses from rental real estate activities. These losses are to be deductible annually. However, that special loss allowance phases out ratably. Ratably means capable of being rated or appraised. This phase out is for taxpayers with AGIs between $100,000 and $150,000. There is no loss, once the phaseout reaches the top of the range. Loss is not allowed. However, in this case, the loss that can’t be deducted can be carried over to future years. That carryover may not do much good year by year for someone whose AGI is consistently over the top of the phaseout range, until the year the property is sold. Also, the deduction for the release of suspension of losses is acceptable.
Do You Have Questions About the Tax Implications of Converting Your Home to a Rental?
For more details related to converting your home to rental use call Alex Franch, BS EA at 781.849.7200. Alex can help you understand how the rules apply to your specific situation. Also, we invite you to comment below or go to our Facebook or Google Plus pages.