First time home-buyer (owner occupied 2 family)

[Sam Dal]

Guys

I really need some advice here. In fact, if you have some time to chat over the phone, please PM me and I'll send you my number

I'm a first time home buyer and hoping for a future in real estate. I currently rent and looking to buy into this 2 family (will occupy one unit myself) and the other one is already rented. I'm trying to make calculations for cash flow but don't know if I can apply the same formulas that you folks use when you buy a bldg and rent the entire bldg

I have concerns around appreciation levels vs SFH, having too little income for the amount of work, etc. This is in Queens, NY within 3 blocks from the rail where I believe 2 family homes are in demand as much as SFH

If someone can spare some time, send me a PM. I'll highly appreciate it

Thanks

[Jon Holdman]

No, the 50% rule does not include depreciation. That's not really an expense, so doesn't directly affect your cash flow.

Taxable income from a rental starts with the actual collected rent. Then you subtract all your actual expenses (taxes, insurance, maintenance, etc., etc.). You also subtract interest. You can't subtract principle payments, though. And you can subtract depreciation. On a property as expensive as this one, that's a big number.

For this property, the "taxable income" is very likely to be a negative number. That's a so-called passive loss. You might be under the impression that you can offset some of your ordinary income with this passive loss. If your AGI is over $150K you cannot. These are "disallowed passive losses.

You can carry forward the disallowed passive losses. When you sell, you can apply the disallowed passive losses against the gain to reduce your taxes. However, when you sell there's another twist you may not be aware of. When you sell, your gain is the sales price less any selling costs less your basis. Your basis starts at the price you paid plus any purchase costs. If you make improvements to a rental property before you put it into service, those add to your basis, too (which means you cannot deduct those costs in the year you spend the money.) As you take the depreciation your basis is decreased by the amount of depreciation you take. Or if for some bizarre reason you don't take the depreciation, you basis is reduced by the depreciation you were allowed to take. So, if you buy for $100K and spend $10K in closing costs and fixup, your basis starts at $110K. Now, say you sell it 13.75 years later. Say your "improvements were worth $88K to start with (80%, a typical rule of thumb), then you would have taken or been allowed to take $44K of depreciation. So, your basis is now $110K-$44K = $66K. Say you sell for $150K with $15K in closing costs for a net sale amount of $135K. Your gain is $135K- $66K=$68K. Now you can apply those carryforward disallowed passive losses.

Yet another twist is you might think your gain is subject to long term capital gains at 15%. You would be mistaken. The gain, up to the amount of depreciation taken or allowed is subject to a recapture tax. That is equal to your ordinary tax rate, but is currently capped at 25%. So, your gain, up to $44K would be subject to 25% tax for this unrecaptured depreciation. Any gain beyond that would be subject to long term capital gains at 15% (currently, I wouldn't bet on it being that 14 years from now.)

If you sell your residence, there is an exclusion of $500K in gains. I am not sure how this works if the property is partially a rental.

A conversation with your CPA would be in order. If you don't have one, you need one. And one that understands real estate. Your taxes will no longer be a DIY project if you go down this road, if you are still doing them yourself. I'm not a CPA and could well be incorrect in some of this. Especially with respect to a mixed property like this.

The 50% number is just an estimate to evaluate a property prior to purchase. For taxes, you use the actual numbers, which can be much different. The 50% number includes costs the IRS considered expenses (i.e, money you pay out that can be deducted in the same year you spend it), capital (money you spend in one year but that has to be depreciated over several), and vacancy (money you never even collect.)