House hack/ live in flip tax optimization

[Andrew S.]

Good morning BP,

I'm currently living in a house hack duplex/ live in flip.

I closed on the property 125k in August, put 10k to make my side 90% complete, then put 7k in the other half. I had my old roommates move in to my half Oct 1st to Nov 15th so I should be able to deduct some of my half's expenses. The other half I should be able to deduct normally. 

My realtor gave me a quick comps for my duplex at ~190k after the renovation. I'm planning to live in it for 2 years to avoid taxes. Possible it will appreciate and I'll fix it up more over 2 years. 

I'm debating if it makes financial sense to get a roommate. I could rent a room for ~$400 per month $4800 per year. If I'm expecting 50k in gains and in the 28% tax bracket - my half 3 bed ~75%? vs other half 1 bed 25%? 

75% of 50k x 28% tax is $9375 in tax due. I'm just doing rough math but it seems like $4800 rent x 2 years isn't worth a $9375 tax bill. And it would make sense to not get a roommate. 

Another question is should I purchase new kitchen cabinets and countertops for my half this year while i have a large deduction already? I assume it doesn't matter because i no longer have roommates so I can't deduct the repairs to my side unless i get a short term roommate?

Thanks for the advice

Andrew 

[Ashish Acharya]

@Andrew S. ,

So many questions packed in one post. I like it. Sorry for the long post. 

1) 10k on your side: if this was improvements, you can add this to the basis of your property that will decrease your gain when you sell.  But, based on your goal this will make no difference because you will qualify for the exclusion. It will come handy if you gain will exceed 250k( highly unlikely in  years) 

• Roommate on your half: You can deduct the repairs and expenses done to his room. You cannot deduct common area expenses. You can depreciate the portion of your side, but that is useless because it is just for a month and a half.  You cannot deduct 10k that you put in becuase of this.  Like mentioned above, these expenses will likely be added to the basis of the property. 

2) 7k on another half: You mentioned you can deduct this. It might not be deductible. This is work done before placing an asset in service ( before renting or advertising). Generally, this will be added to the basis of the property and depreciated, unless you meet the requirements of some safe harbors ( de minimis). 

Keep these two things in mind when you work on your duplex:

Repairs:

1) Repairs made on the personal side of the duplex cannot be deducted. It is a personal expense, just like your food expense.

2) Repairs made on the duplex are deductible against the rental income.

Improvements:

1) Improvements made on personal side are added to the basis of the property, but you cannot depreciate the personal side of the property. The increase of the basis will help you minimize the taxable gain when you eventually sell the house.

2) Improvements made on the rented side will also be added to the basis, but you can depreciate the improvements on the rental side and deduct depreciation against the rental income. But, you have to recapture the depreciation (pay taxes again on what was deducted ) at the end when you sell the house.

So, a good strategy is:

A) For the personal side, do not do repairs because they are personal. Always do improvements because they increase your basis thus reduce taxable gain in the future.

B) For the rental side, do repairs because they are deductible right away and do not have to depreciate over a few years as done for improvements. Repairs do not have to recapture when you sell the house too.

Also, I am struggling with your tax calculation.  if you expect 50k gain when you sale in 2 years. 

1) 25 k gain will be tax-free because you are going to live in it for 2 years(sec 121 exclusion).

2) 25k on the duplex side will be taxed at a capital gain rate ( not 28%)- Most likely 15% if your AGI is below 40k. Part of the gain it will be taxed at max 25 %. this is unrecaptured depreciation.

You will have this tax no matter if you rent your side to one roommate. You will still qualify for sec 121 exclusion on your side even if you rent a room for a roommate.