Wednesday, January 6, 2010

Real Estate and Tax Issues (Part 2)

Some Personal Use of the Rental Property

If you used the rental property for your own personal use, the tax treatment will depend upon how many days it was used for personal reasons.

If you used it less than 15 days or 10% of the days it was available as a rental property, there are no limitations to the deductions other than the $25,000 rule as stated above. All expenses, including depreciation, are deductible and a loss can be recognized if you meet the income tests. However, the situation changes drastically if your personal use exceeds 14 days or 10% of the rental days. In this situation, you still are permitted to claim tax deductions for your expenses, but the expenses cannot exceed the rental income reported on the tax return.

If your expenses for mortgage interest and taxes exceed your rental income, you are permitted to deduct any of the excess interest and/or tax expenses on Schedule A (this tax deduction is often missed). For example, if you rent your real estate out for 300 days in 2009 and you used it for 12 days, you would be fine as your personal use was less than 10% of the days it was available for rent (30 days in this case) or 15 days. All of the expenses would be deductible and a loss would be permitted, assuming you meet the income requirements. If you used it for 25 personal days, no loss would be permitted.

Rental Property Rented Less Than 14 Days Per Year

In this category, you are not permitted to deduct any expenses except for mortgage interest, taxes and possibly an uninsured casualty loss for the property. While this may sound like a bad deal, it is actually very good, as the flip side of this is that you are not required to report any of the rental income for this property.

It does not matter how much money you received for the rental income– it is not considered to be taxable income. This very favorable tax provision works well for many different locations in the United States. For instance, if you own a ski condominium in Colorado and rent it out over the Christmas or Spring Breaks, you can charge a premium rental amount and have no income to report on your tax return. The same can be said for special events (such as renting your home to spectators at sporting events, such as the World Series, golf tournaments, Olympics, etc.).

Conversion to Personal Residence

If you sell your rental property, you will almost certainly be subject to capital gains taxes and possibly the need to recapture any depreciation claimed on the property.

One possible way to save some dollars on taxes (although the depreciation recapture rules may still apply) is to covert your rental property into your personal residence before you make the sale. In order to do this, you will need to satisfy the “two years out of five years” rules for ownership and occupancy. If you can do this, you will avoid the capital gains taxes and be able to qualify for up to $500,000 of tax-free gains.

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