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Hello fellow Fools,

DW and I are planning to purchase a condominium unit for rental property. We currently own a home acquired debt free from a parent that we rent out, so the world of Schedule E and Form 4562 is not totally foreign. However, this is our first venture into the world of financed rental property.

The facts of the matter…

Our daughter has bought a house and is selling her condo which we have agreed to purchase. She is a loan officer with a local mortgage broker and will arrange all financing.

Financing:

80% fixed rate first mortgage; Closing costs below
20% HELOC (on our personal residence); No closing costs.

Closing costs (first mortgage) ~$1,360 as listed on Good Faith Estimate:

Item 803 Appraisal fee 200
Item 811 Underwriting fee 425
Item 1101 Closing/escrow fee (Title Company) 125
Item 1108 Title Insurance (Title Company) 325
Item 1202 Recording fees (County) 75
Lender fee to forego Item 1004 Taxes/Assessment Reserves 210

Assumptions:

15% tax bracket.

…and now some issues/questions:

1. Financing costs deductibility. I (know/think) interest paid on the first mortgage is a deductible expense. But, is the interest paid on the HELOC, secured by our personal residence, a deductible business expense?

2. Closing cost deductibility. When I read some of the IRS pubs e.g., 936, my eyes glaze over. Then I realize we're talking investment property, not personal residence, so now I'm not at all sure where I should be looking. Given the closing costs items above, which are deductible and which must be amortized? Is paying the lender a fee to avoid escrow of RE taxes a legitimate business expense? What pubs should we be reading?

3. Determining the condominium's depreciation basis. - County tax records show a 21% Land, 79% Improvements relationship for tax assessment. Is this a reasonable method to determine the basis for depreciation? (purchase price times 79%)?

County tax records contain the statement “BLDG 2 UNIT A 3.22% IN COMMON ELEMENTS (11389 2167)”. What, if anything, does this have to do with figuring depreciation?

Thanks for your help.

George
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80% fixed rate first mortgage; Closing costs below
20% HELOC (on our personal residence); No closing costs.

Closing costs (first mortgage) ~$1,360 as listed on Good Faith Estimate:
Item 803 Appraisal fee 200Item 811 Underwriting fee 425Item 1101 Closing/escrow fee (Title Company) 125Item 1108 Title Insurance (Title Company) 325Item 1202 Recording fees (County) 75Lender fee to forego Item 1004 Taxes/Assessment Reserves 210

Assumptions:

15% tax bracket.

…and now some issues/questions:

1. Financing costs deductibility. I (know/think) interest paid on the first mortgage is a deductible expense. But, is the interest paid on the HELOC, secured by our personal residence, a deductible business expense?


I don't know what a HELOC is, but if a loan is financing the rental property, the interest on the loan is an expense against the rental income.

2. Closing cost deductibility. When I read some of the IRS pubs e.g., 936, my eyes glaze over. Then I realize we're talking investment property, not personal residence, so now I'm not at all sure where I should be looking. Given the closing costs items above, which are deductible and which must be amortized? Is paying the lender a fee to avoid escrow of RE taxes a legitimate business expense? What pubs should we be reading?

Check out Pub 527. I'm not an expert in this area, but it seems to me that all should be capitalized, except for item 75, which I wouldn't pay unless this is the only lender on the face of the earth.

3. Determining the condominium's depreciation basis. - County tax records show a 21% Land, 79% Improvements relationship for tax assessment. Is this a reasonable method to determine the basis for depreciation? (purchase price times 79%)?

That's how I'd do it, remembering that capitalized purchase expenses (and any immediate capital improvements) are part of your depreciable basis.

County tax records contain the statement “BLDG 2 UNIT A 3.22% IN COMMON ELEMENTS (11389 2167)”. What, if anything, does this have to do with figuring depreciation?

Nothing.

Phil Marti
VITA Volunteer
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I don't know what a HELOC is, but if a loan is financing the rental property, the interest on the loan is an expense against the rental income.

HELOC = Home Equity Line Of Credit. I guess we could write a check for any purpose up to the limit and deduct the interest on Sch A. But we plan to only using the HELOC for business expenses for the condo and hope the interest would be deductible on Sch E.

...except for item 75, which I wouldn't pay unless this is the only lender on the face of the earth.

If you really meant "Lender fee to forego Item 1004 Taxes/Assessment Reserves" I guess you are correct, let them earn the interest on the RE taxes escrow account.

That's how I'd do it, remembering that capitalized purchase expenses (and any immediate capital improvements) are part of your depreciable basis.

Thanks for the reminder and for your response to my questions.

George
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HELOC = Home Equity Line Of Credit. I guess we could write a check for any purpose up to the limit and deduct the interest on Sch A. But we plan to only using the HELOC for business expenses for the condo and hope the interest would be deductible on Sch E.

Uh...not quite. If you were using the HELOC for personal purposes (ie, not for financing the rental property or other investment or business purposes) you could only deduct the interest on up to $100,000 of principal you borrowed. This maximum would be reduced by any primary mortgage principal balance in excess of acquisition debt. See the ordering rules and limits in IRS Pub. 936, Home Mortgage Interest Deduction.

www.irs.gov/pub/irs-pdf/p936.pdf

Ira
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HELOC = Home Equity Line Of Credit. I guess we could write a check for any purpose up to the limit and deduct the interest on Sch A. But we plan to only using the HELOC for business expenses for the condo and hope the interest would be deductible on Sch E.

I am no expert, but I imagine your HELOC interest would be deductible against your income, and your HELOC funded business expenses would be deductible against your revenue.
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I am no expert, but I imagine your HELOC interest would be deductible against your income, and your HELOC funded business expenses would be deductible against your revenue.

Precisely my hope.

George
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Ira

Uh...not quite. If you were using the HELOC for personal purposes (ie, not for financing the rental property or other investment or business purposes) you could only deduct the interest on up to $100,000 of principal you borrowed. This maximum would be reduced by any primary mortgage principal balance in excess of acquisition debt. See the ordering rules and limits in IRS Pub. 936, Home Mortgage Interest Deduction.

Pub 936...glazed eyes, again... please bear with me on this. An example: Rental condo $100k, first mortgage $80k, 20% down payment in the form of a $20k HELOC plus capitalized closing costs $1,150. After closing we would have a $21,150 HELOC mortgage/loan all related to the acquisition of the rental condo.

Given this example, all of the interest on the HELOC would be deductible on Sch E for the condo, correct?

Interest on future draws on the HELOC for condo related expenses (e.g., repairs, improvements, etc.) would also be deductible, correct?

Interest on future draws on the HELOC for personal purposes would NOT be deductible, correct?

As long as we do not exceed the $100,000 limitation, no problem, correct?

Thanks for your patience

George
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Does selling to a family create any tax issues?

Debra

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Does selling to a family create any tax issues?

Don't know and didn't ask. We are buying at appraised and fair market value (want daughter to get a good price). Might be a very different story if we buy below market value.

George
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Pub 936...glazed eyes, again... please bear with me on this. An example: Rental condo $100k, first mortgage $80k, 20% down payment in the form of a $20k HELOC plus capitalized closing costs $1,150. After closing we would have a $21,150 HELOC mortgage/loan all related to the acquisition of the rental condo.

Given this example, all of the interest on the HELOC would be deductible on Sch E for the condo, correct?

Interest on future draws on the HELOC for condo related expenses (e.g., repairs, improvements, etc.) would also be deductible, correct?

Interest on future draws on the HELOC for personal purposes would NOT be deductible, correct?

As long as we do not exceed the $100,000 limitation, no problem, correct?


Close. You have the rental interest correct.

For the personal mortgage and HELOC interest you have to ignore the rental property and any principal borrowed to finance it. You can deduct the interest on an additional $100K of HELOC principal beyond the amount borrowed for the rental. This $100K of principal will be reduced if you've already refinanced your primary mortgage and taken additional cash out.

IRS Pub. 936 is pretty straightforward as long as you remember to treat the rental and personal borrowings as independent of each other.

Ira
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Ira

Close. You have the rental interest correct.

For the personal mortgage and HELOC interest you have to ignore the rental property and any principal borrowed to finance it. You can deduct the interest on an additional $100K of HELOC principal beyond the amount borrowed for the rental. This $100K of principal will be reduced if you've already refinanced your primary mortgage and taken additional cash out.


I think I'm finally getting it. If I read you correctly, I need to view and treat this as two separate loans, rental business and personal. Interest related to rental is deducted on Sch.E. Interest related to personal use is deducted on Sch A (unlikely because standard deduction will be greater than itemized deductions).

Thanks for your patience and explanation!

George
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I think I'm finally getting it. If I read you correctly, I need to view and treat this as two separate loans, rental business and personal. Interest related to rental is deducted on Sch.E. Interest related to personal use is deducted on Sch A (unlikely because standard deduction will be greater than itemized deductions).

Correct. Only interest related to personal use is subject to the limitations described in IRS Pub. 936.

I am somewhat surprised that you won't be itemizing. Usually, a home mortgage plus real estate taxes plus state income taxes plus charitable contributions are enough to exceed the standard deduction. Of course, if you live in a state without a personal income tax all bets are off.

Ira
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Ira

Correct. Only interest related to personal use is subject to the limitations described in IRS Pub. 936.

Thanks for the confirmation.

I am somewhat surprised that you won't be itemizing. Usually, a home mortgage plus real estate taxes plus state income taxes plus charitable contributions are enough to exceed the standard deduction. Of course, if you live in a state without a personal income tax all bets are off.

Several reasons: Low taxable income, thankfully low medical expenses, the 'home mortgage' and HELOC are on the rental condo which offset income, no mortgage on personal residence and RE taxes not too bad but getting worse, charitable contributions could be higher, Missouri income tax is ~ 6%. All in all, still fall short of of standard deduction.

George
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Hi George,

I don't know your AMT situation, but interest on home equity loans is added back for AMT.

"Interest on a mortgge taken out after June 30, 1982 is not deductible for AMT purposes if the proceds are used for an purpose other than to buy ,build or substantially improve your principal or second residence." JK Lasser's Your Income Tax 2003

It reads easier than the IRS stuff.

buzman
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buzman

I don't know your AMT situation, but interest on home equity loans is added back for AMT.
"Interest on a mortgge taken out after June 30, 1982 is not deductible for AMT purposes if the proceds are used for an purpose other than to buy ,build or substantially improve your principal or second residence." JK Lasser's Your Income Tax 2003


I don't know either but, I hope not. Would AMT be involved with interest paid on HELOC money to acquire rental RE? I can see AMT involved with other, personal use, HELOC draws.

Thanks, George
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"Interest on a mortgge taken out after June 30, 1982 is not deductible for AMT purposes if the proceds are used for an purpose other than to buy ,build or substantially improve your principal or second residence." JK Lasser's Your Income Tax 2003

The way that I read this indicates the mortgage would be added back for AMT, but I'm not an accountant. FWIW, AMT will snare more taxpayers each year.

buzman

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buzman

Thanks for your response. Guess I'll have to do the AMT check next tax season.

George
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