Rent my primary residence to myself.

[Derek Smith]

Hello everyone, 

Ever since the new tax laws went into place where you have to be uber rich in order to write off your mortgage interest. I've been trying to think of ways to move my mortgage to my investment properties so I can continue to write it off.

All options I've come up with either 1) drain my savings, and or 2) increase cash out every month. neither is a really good investment considering my 3.75% 30yr mortgage.

BUT....

This morning I had an idea that I could turn my primary residence into a rental, and just rent it to myself.

Yes, this would mean I would incur additional income from the rent, but I think that would be more than offset by depreciation, interest, taxes, repairs, etc. Showing a net loss and reducing my taxable income.

What are the legal/ ethical dilemmas of doing this? i did some research and it looks like the uber rich already employ this strategy.

Would I need to form a LLC and transfer ownership? (I don't have my other rentals in an LLC) Or can I just draw up a lease and voila?

What am I missing/ not thinking about here?

[Brian Van Pelt]

I would think that the tax's on the additional income would make it a wash.

In addition you might (I'm not 100% sure) lose the 250K tax free deduction when you sell your primary residence, as it could be argued that it is ... well, a rental property and not your primary residence.

When you have multiple properties and travel between them, it makes sense, not so sure on a single residence or everyone would be doing it and it would be all over the news, internet.

[Dominick Austria]

@Derek Smith simply put you can’t do this. You also didn’t lose any benefit. It actually sounds like you gained since you can’t itemize anymore.

[Mike Freske]

Originally posted by @Dominick Austria:

@Derek Smith simply put you can’t do this. You also didn’t lose any benefit. It actually sounds like you gained since you can’t itemize anymore.

 This

[Eamonn McElroy]

@Derek Smith

You cannot rent a house that you own to yourself as a principal residence.  Well... you can but the transactions will be disallowed for income tax purposes.

"Self rental" in the tax world usually means rental of a property the taxpayer owns to a business the taxpayer controls.  (e.g. a lawyer buys a commercial building and rents it to his wholly-owned S Corp law practice).  Self rentals are treated differently than regular third-party rentals for income tax purposes.  This is probably what you read about.  The "uber rich" are not doing self rental with their principal residence.

[Lance Lvovsky]

@Derek Smith

What was said above is correct. Also the Treasury will take the position of substance over form. In other words, what is the economic substance of the transaction? And what is the non tax reason for the transaction? In short, your idea does not work.

[Curt Riffel]

I have seen some self-rental of a primary residence, but it usually involves only a portion of the house as an 'office' for their S-Corp or Partnership. 

[Derek Smith]

Originally posted by @Mike Freske:

Originally posted by @Dominick Austria:

@Derek Smith simply put you can’t do this. You also didn’t lose any benefit. It actually sounds like you gained since you can’t itemize anymore.

 This

Well, I paid about 60k in taxes last year. Which was more than 2017, without making proportionally more in 2018.

So no, I didn’t gain.

If you familiar, the tax rules changed last year making the standard deduction larger, but also removing things like home office deductions. (I run a small business from my house, ~140k/ year, plus my W2 job, plus my wife’s W2 job, plus rentals)

Overall itemizing puts me just under the standard deduction, because of the changes that were made.

So simply put, I appreciate the criticism. I would appreciate it more if it were constructive.

[Derek Smith]

Originally posted by @Lance Lvovsky:

@Derek Smith

What was said above is correct. Also the Treasury will take the position of substance over form. In other words, what is the economic substance of the transaction? And what is the non tax reason for the transaction? In short, your idea does not work.

 Where in the tax code would I find this? 26 CFR XX?

I get that this is solely for tax purposes, but what makes that different than any other strategy for minimizing taxes? 

How is it decided what is substantive vs not?

The one issue I’ve read about but haven’t actually read in the tax code yet is, you can’t deduct passive losses from active income. I may have enough passive income to make it worth it but I haven’t run all the numbers and I’m not sure. Still just spitballing the issues around it.

[Mike Freske]

@Derek Smith

I am no tax expert, however, based on what you have told us, I'm not sure why you couldn't take home office deductions?  Those would go on your Schedule C and have nothing to do with itemizing versus standard deduction.

I, too, have a W2 job and a home business and I took business deductions, including a home office. Those are two separate things.

Also, read above from two accountants regarding self-rentals.

[Derek Smith]

Originally posted by @Eamonn McElroy:

@Derek Smith

You cannot rent a house that you own to yourself as a principal residence.  Well... you can but the transactions will be disallowed for income tax purposes.

"Self rental" in the tax world usually means rental of a property the taxpayer owns to a business the taxpayer controls.  (e.g. a lawyer buys a commercial building and rents it to his wholly-owned S Corp law practice).  Self rentals are treated differently than regular third-party rentals for income tax purposes.  This is probably what you read about.  The "uber rich" are not doing self rental with their principal residence.

 Right, you don’t have to be super wealthy to own your own business and rent space to it. 

What I thought was, people were using this strategy when they owned multiple homes, where none were rented to other people. They were somehow owned in a separate entity and paid rent from the individual for the purpose of minimizing taxes.

I haven’t been able to find much about it so far. What’s so different if you only have 1 primary residence you live in?

[Dominick Austria]

Originally posted by @Derek Smith:

Originally posted by @Mike Freske:

Originally posted by @Dominick Austria:

@Derek Smith simply put you can’t do this. You also didn’t lose any benefit. It actually sounds like you gained since you can’t itemize anymore.

 This

Well, I paid about 60k in taxes last year. Which was more than 2017, without making proportionally more in 2018.

So no, I didn’t gain.

If you familiar, the tax rules changed last year making the standard deduction larger, but also removing things like home office deductions. (I run a small business from my house, ~140k/ year, plus my W2 job, plus my wife’s W2 job, plus rentals)

Overall itemizing puts me just under the standard deduction, because of the changes that were made.

So simply put, I appreciate the criticism. I would appreciate it more if it were constructive.

Sorry for sounding brash. The home office deduction is still alllowable. It’s just not allowable for W-2 employees. If you are still running a business out of your home you should be able to take the deduction. $140k is a big number. Are you a sole proprietor for this business or set up like an S Corp? There might be potential to save tax there. Are you maximizing the new QBI 20% deduction? Could you move things around to get that to be bigger? You should talk to your CPA or tax advisor about things you might not already be doing.

[Eamonn McElroy]

@Derek Smith

You cannot turn personal, non-deductible expenses into deductible expenses.  @Lance Lvovsky already mentioned "substance over form".  It is a Accounting 101 concept that dictates you cannot change the treatment of a specific transaction by structuring it differently.  This is what I think you're missing and where you need to focus.  Point blank, you cannot get around the $10k personal tax expense limitation and the mortgage interest limitations.

"If you familiar, the tax rules changed last year...removing things like home office deductions. (I run a small business from my house, ~140k/ year, plus my W2 job, plus my wife’s W2 job, plus rentals)"

Except it didn't...  Nothing changed for home office deductions under the TCJA.  The only thing that changed that could affect home office deductions are the suspension of miscellaneous 2% itemized deductions through 2026...which means an S Corp shareholder cannot claim a home office deduction on Schedule A.  My opinion, which predates the TCJA, is that claiming a home office deduction on Schedule A for an S Corp shareholder is not advantageous.  For years I've told clients an accountable plan is more advantageous (and is especially so in the wake of the TCJA).

"Where in the tax code would I find this? 26 CFR XX?"

There's a doctrine regularly referenced by the courts called the "legislative grace doctrine".  In a nutshell, it means that the burden of showing a right to claim a deduction is on the taxpayer.  IRC Sec163(h) and 164(b)(6) specifically allow deductions up to a limit for personal mortgage interest and personal property taxes if a individual taxpayer itemizes deductions.  IRC Sec 262 specifically disallows all other personal deductions, which includes personal residence insurance.  When you attempt to get around these specific IRC code sections, you are in violation of the the judge-made-law "sham transaction doctrine".  You should google it.

Simply put, what you're proposing won't work.  You have no authority for it, let alone substantial authority.  You shouldn't be looking for the code section that tells you "you can't do this".  You should be looking for the code section that tells you "you can do this".

"I get that this is solely for tax purposes, but what makes that different than any other strategy for minimizing taxes?"

At best it's negligent.  At worst it's fraudulent.

"Right, you don’t have to be super wealthy to own your own business and rent space to it."

Yes...except that's not what you asserted and not what I responded to.  You asserted: "This morning I had an idea that I could turn my primary residence into a rental, and just rent it to myself...i did some research and it looks like the uber rich already employ this strategy."  You weren't talking about renting real property to a wholly-owned business.

"What’s so different if you only have 1 primary residence you live in?"

I'm not sure what you're asking or getting at here... according to the definition of the word "primary" everyone only has one "primary" residence.

[Derek Smith]

Originally posted by @Dominick Austria:

Originally posted by @Derek Smith:

Originally posted by @Mike Freske:

Originally posted by @Dominick Austria:

@Derek Smith simply put you can’t do this. You also didn’t lose any benefit. It actually sounds like you gained since you can’t itemize anymore.

 This

Well, I paid about 60k in taxes last year. Which was more than 2017, without making proportionally more in 2018.

So no, I didn’t gain.

If you familiar, the tax rules changed last year making the standard deduction larger, but also removing things like home office deductions. (I run a small business from my house, ~140k/ year, plus my W2 job, plus my wife’s W2 job, plus rentals)

Overall itemizing puts me just under the standard deduction, because of the changes that were made.

So simply put, I appreciate the criticism. I would appreciate it more if it were constructive.

Sorry for sounding brash. The home office deduction is still alllowable. It’s just not allowable for W-2 employees. If you are still running a business out of your home you should be able to take the deduction. $140k is a big number. Are you a sole proprietor for this business or set up like an S Corp? There might be potential to save tax there. Are you maximizing the new QBI 20% deduction? Could you move things around to get that to be bigger? You should talk to your CPA or tax advisor about things you might not already be doing.

Thank you,

I am both a W2 employee, as well as a S-corp owner with W2 income. So the home office deduction is not available to me.

$140k was revenue, not net.

I will look into the QBI deduction, I don't remember that from last year. 

I will look into a tax adviser, I've met with CPA's and gone over plans in the past. But they've never been able to recommend doing much different than I already do.