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<It appears to me that the common strategy is to write off a whole slew of expenses against the rental income, essentially negating it if possible.>

Yes, you're right on target. The biggest tripping point here is when you start confusing repair & maintenance with capital improvements. R&M is a current expense, CI is a depreciable expense. Everyone prefers to take the whole expense immediately, but the IRS frowns on people who confuse the two. Be careful. For example, a new roof is a CI, not R&M. But in your mind you can convince yourself that putting on a new roof really was just good ol' fixin up to "maintain" your home.

<How is mortgage interest attributed to rental unit (1st floor) vs my unit (2nd and 3rd floors)? Is
mortgage principal payment also an expense to be written off against rental income?>

Interest (which will be shown on the loan summary sent to you each January, along with taxes and insurance paid) will usually be prorated based on the square footage of rental vs. the whole house. I owned (just sold it last June) a 1st & 2nd floor duplex and lived in half, so for me it was an easy 50/50 split for interest, taxes, and insurance. Remember to factor in common areas (the basement, if you both have access to it for laundry) when figuring sq. ft.

As for principal, NO! The value of your house (the rental portion) is being depreciated over 27.5 years. That's it.

<Also, is it generally wise to write off a portion of the value of the property as depreciation, or does
this somehow impact your capital gains when you sell?>

(Wow, deja vu) Yes and yes. The catch is that even though you will "recapture" the depreciation when the house is sold, not taking the depreciation doesn't let you avoid the recapture. Huh!? For simplicity, let's say the entire property is a rental and costs 100k. Let's say you take 5K in depreciation expense over the years and then sell the house for 105K.

You're new basis would be 95k. You would have 5K of capital gains and 5k of depreciation recapture. That 5k of recaptured depreciation is taxed at a less favorable rate (up to 25%) than the long term capital gains rate (up to 20%). But the catch is that even if you didn't take the depreciation, the IRS views it as an allowed deduction so the depreciation is still factored in to bring you to a 95K basis. In other words, take the depreciation now because you'll still pay for it later.

On important note: If you're doing this without an accountant, those depreciation schedules require attention, both in selecting the correct one and in making sure the right annual percentage is being applied. If you add a roof, it's part of the structure so it will be depreciated evenly (straight line depreciation) over 27.5 years. If you add carpeting, that uses the 7 year schedule with a different percentage being deducted each year (modified accelerated depreciation). Just a quick illustration, but don't be scared by it. It's learnable.

<I have a load of questions, so a good reference book or site on the WWW would also be appreciated.>

The best references I found were IRS Publications 527 (rental property) and 946 (depreciation), and the instructions for schedules "E" (rental property) and 4562 (depreciation). But I guess you meant a good refernce book written in English, not IRS sanskrit. Maybe TMFTaxes or KAT will have some suggestions.
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