If I live-in my triplex, do I have to pay taxes on rental income earned?

Question

To my understanding, actually living in the premises, especially being a 3-home or less, will put you into a different mortgage bracket, tax bracket, etc...

Do I need to claim my rental incomes and then pay taxes on them at the end of the year?

Jon Holdman · Answer

Depreciation is based on the value of the property.  A common rule of thumb is that 80% of the price you pay is the "improvements" and 20% is that land.  You take depreciation on the improvements, but not on the land.  Improvements are depreciated over 27.5 years.  So you take the value of the improvements and divide by 27.5 to get the annual depreciation.

Now, the first year you own is probably not a full year.  Depreciation starts when its rent ready.  If that's Jan 1, you get a full year's depreciation.  If its, say, July 1, you can only take a half year depreciation.

Now, a better method to calculate the value of the improvements is to look at the county assessors valuation.  They will have an amount for the land and an amount for the improvements.  Use those to compute the ratio and use that instead of the standard 80%.  Don't use their values, just the ratio.  That is (assessor's value for the improvements / assessor's total value.)

Most rentals don't produce a lot of taxable income.  Many are actually negative.  If the net taxable income is positive, you will pay tax on it at your marginal rate.  Its EXACTLY the same as if you received that amount as a raise at your day job.  So, the amount of tax depends on your current AGI.  You can find your AGI on your previous year 1040EZ.  Then google "2012 tax brackets" and figure out your rate.

If the net taxable income is negative, you may be able to use that passive loss to offset some of your ordinary income.  If your AGI (married or single, doesn't matter) is under $100K, you can reduce your other income by the passive loss, up to $25,000.   If its over $150K, you cannot.  In between, that $25,000 limit is reduced by $1 for every $2 of income in your AGI over $100K.

You're not going to make $15,000 in NET rental income.  You may collect $15,000 in gross rents, but after you subtract taxes, interest, insurance, maintenance, tenant screening fees, your CPAs fee (yes, that's deductible, at least in part), utilities, etc., etc., etc and then you subtract the depreciation (which is not actually money out of your pocket), the NET rental income will be much less.

You said "Your talking a little over my head here in terminology".  Understand.  This stuff is complicated.  That's why you MUST get a CPA who's experienced in real estate investing.  Especially the first year.  The initial expenses and purchase transaction are especially complex.  You living it in makes it complex, both now and in the future.  This is just not a DIY project.

You initially said your friend was a VP of finance at a corporation.  That means he's knowledgeable about doing the accounting for a company.  That's not the same as doing any particular form of investing.

Then you said he owns a brokerage.  Real estate brokerage?  OK, that's better.  But in all honestly, I've ran across MANY brokers, perhaps even MOST real estate brokers, who really don't have a clue about real estate investing.  A broker's job is to facilitate real estate transactions.  An investors job is to buy rentals that will make a profit.  A broker is perfectly happy to sell an investor a $200K house that rents for $1000.  They collect a commission and move onto the next deal.  I've seen many brokers write "this cash flows" in the MLS remarks.   What they mean is "if you put 20% down, your rent will be just a tiny bit more than your PITI payment".  That's not "cash flow".  That's a loser.  An investor is going to losing big-time on a rental like my example.

Ann Bellamy · Answer

I'm not an accountant, but I'll tell you my experience.

All rental income separated by property goes on schedule E.  From the income gets deducted the expenses, also on schedule E.  One of the deductions is depreciation on the property.  So it reduces your income substantially.  You will, if you later sell the property, pay recapture taxes on that depreciation, however, but you have to take the depreciation.  Don't decide that you don't have to take the depreciation.  If you don't understand it, get an accountant.

A property occupied as your primary with rental income still goes on the schedule E.  The expenses are then deducted in a pro-rata share on that schedule E.  So if the tenants occupy 65% of the property, then 65% of the expenses also get deducted from that income.  That includes interest.  So 65% of the interest and taxes get deducted on schedule E.  The rest of the 35% of taxes and interest get deducted on your Schedule A.  You can no longer do the 1040 EZ.

Ann Bellamy · Answer

Matt, no one can answer that without also knowing your expenses, and your entire tax situation - 
Your other income, other deductions, etc

You will pay taxes according to your overall AGI less credits, etc.  The amount that will be part of that that relates to your income property is

Gross income
less expenses
less depreciation

The net figure of that gets added into your income and then the rest of your return is calculated.  So we don't have enough information to answer your question.  And probably shouldn't be answering it anyway, except for the few accountants on BP.

If you were previously filing 1040EZ, your return will be quite simple and can probably be done on your own, but since you don't know the terms that Jon and I are discussing, strongly recommend you just get all your records together and get to your accountant.  Then have him explain to you the different tax implications once he's done.  It is important that you understand the tax implications, even if you don't do it yourself.

Matt M. · Answer

Maybe a stupid question... but how will the state know I've been collecting income?

Matt M. · Answer

Awesome replies in here, so I'm just going to ask the questions w/out trying to quote everything.

I understand net= gross-costs. Thats simple math.

My friend who's VP of finance does stocks as well as real estate investments. He buys properties and rents them out for cash... namely warehouses and office buildings, but also some housing units. I'm not going to rely on him for ANYTHING other than keeping my books and making sure that I'm not losing any more money than I need to be.

Yes, taxes suck.... I dont believe in them. I've been "blessed" with living in tax-hungry NYS.. yay me.

For numbers:
Going to buy something between 80-90k tops.... will probably put 10k down and keep a some leftover for improvements. I will probably be asking about $650/mon, give or take, depending which facility I find. I'll be getting a tri-plex, so thats roughly $1400/mon. No PMI if I go w/ a VA loan, otherwise I'm not too terribly worried about the cost.

For a $96,500 loan I'm looking about $842/month for all insurance/taxes/fees/mortgage. If I get a house for less than $92.5, which I fully plan to do, obviously this number will go down.

Steven Hamilton II · Answer

Matt M,

You have to claim all income received in the year regardless of where it came from.

There is no such thing as a different mortgage bracket, You need to determine your income and expenses for the property.  You then need to include all of the rents receved You will then deduct all of the eligible expenses, then mortgage interest and then depreciation to determine if you had a profit or loss.

Income 
-Expenses
= Profit

X Tax rate

= Tax due

Honestly, Everyone has given you excellent answers that are very well explained.  Being that you are not understanding them, I one of the more active accounts on the board, Without sitting you in front of me an explaining it I don't think you would get it as you are confusing some of the basics.  It would be easier for someone to walk you through it step by step.

That said,  Are you sure being a landlord is a good situation for you?  You may want to consider a different type of investment, be sure you understand all that is required of being a landlord.

-Steven

Jon Holdman · Answer

Give us some numbers.  What are the rents?  What percentage, square foot wise, is rented?  What's your P&I payment.  What did you pay.  From those, I can estimate your net rental income, at least for a full year.  Then you can look at your AGI and look up the tax brackets and estimate your tax.

Steve Babiak · Answer

ALL taxes SUCK!  They all suck money from you.  Whether that is ever fair or not is another discussion altogether (start a thread in the "off topic" area if you think it's worth discussion).

Matt M. · Answer

Craig Shute Ah that clears it up... thank you. Yes I mean sales tax.

Jeff Bridges So is the probability of me owing money or receiving money greater with rental property? I'm leaning towards I'm gonna owe money aren't I....

Jeff Bridges · Answer

If I'm not mistaken, the net cashflow (income minus all related expenses) is taxed according to your income tax bracket, which is around 30%. You will owe ~30% of whatever "net cashlow" you earn. If you were to have negative cashflow or a loss, that gets subtracted from your taxable income from your full time job for example and then they ask for 30% of that new lower total.

This would be good for a rough calculation, so you know not to spend the entire amount of the proceeds so you have them to pay when you prepare your tax return and pay your outstanding taxes.

If I live-in my triplex, do I have to pay taxes on rental income earned?

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