Questions About Taxes for a House Hack

[Shannon Richardson]

I just purchased my first investment as a house hack, with the intent of living there for a year or two, and I am seeking clarification on a few things relating to the accounting side of this. The property is a 3-unit and I'm planning on doing some work to each one over time, in addition to the house itself. If I'm saying anything wrong please correct me, but my understanding is that any repairs or improvements that I perform to my unit will not be tax deductible, but after I convert it to a rental will be wrapped into the property's basis for depreciation. Any repairs that I do on a rental are deductible, and any improvements will be added to the property's basis. Work pertaining to the house itself will be split by a percentage based on occupied space, being deductible or depreciable based on whether it is a repair or improvement respectively. 

To do everything by the book while maximizing my tax benefits, some questions that I have about this are:

-Should I keep separate bookkeeping logs for the rental side of the house and the unit I'll be living in?

-Would non-structural improvements to the unit I'm living in (I.e. updating appliances, flooring, etc.) be on a reduced depreciation schedule, or would it all fall under the 27.5 year schedule of the property? And would that schedule just take off the time I've lived there (26.5 year depreciation if lived in for 1 year)?

-Would the purchase of tools/equipment/materials used to perform work on both sides of the property be split by a %, or would that be fully depreciable under my business?

-Are major capital expenditures (namely roof, furnace, ac, water heater) considered improvements even after they are past their rated lifespan? What if one fails?

-Would it be more beneficial to take care of these capital expenditures after I've moved out?

I'm in the process of looking for a CPA for help on some of this, but any input is greatly appreciated!

[Linda Weygant]

Originally posted by @Shannon Richardson:

I just purchased my first investment as a house hack, with the intent of living there for a year or two, and I am seeking clarification on a few things relating to the accounting side of this. The property is a 3-unit and I'm planning on doing some work to each one over time, in addition to the house itself. If I'm saying anything wrong please correct me, but my understanding is that any repairs or improvements that I perform to my unit will not be tax deductible, but after I convert it to a rental will be wrapped into the property's basis for depreciation. Any repairs that I do on a rental are deductible, and any improvements will be added to the property's basis. Work pertaining to the house itself will be split by a percentage based on occupied space, being deductible or depreciable based on whether it is a repair or improvement respectively. 

To do everything by the book while maximizing my tax benefits, some questions that I have about this are:

-Should I keep separate bookkeeping logs for the rental side of the house and the unit I'll be living in?

-Would non-structural improvements to the unit I'm living in (I.e. updating appliances, flooring, etc.) be on a reduced depreciation schedule, or would it all fall under the 27.5 year schedule of the property? And would that schedule just take off the time I've lived there (26.5 year depreciation if lived in for 1 year)?

-Would the purchase of tools/equipment/materials used to perform work on both sides of the property be split by a %, or would that be fully depreciable under my business?

-Are major capital expenditures (namely roof, furnace, ac, water heater) considered improvements even after they are past their rated lifespan? What if one fails?

-Would it be more beneficial to take care of these capital expenditures after I've moved out?

I'm in the process of looking for a CPA for help on some of this, but any input is greatly appreciated!

 Hi Shannon, 

I'll offer up some basic advice that I give to all my house hacker clients as well as answer some of your specific questions.

There's no need to keep a formal set of books for something you're househacking - particularly if it's your first property.  What you will need is a way to categorize things into three properties

a.  Expenses for the rental portion specifically - things like background checking expenses, repairs to that specific unit or a utility bill that is separately metered from the rest of the building, etc.

b.  Expenses for your unit specifically - again, utility bills, repairs, etc.

c.  Expenses for the building as a whole - insurance, property taxes, a utility bill that is not separately metered, etc.

At the end of the year, my clients give me the data broken out as above and I work the calculations (generally based on square footage) to get an appropriate percentage for the shared expenses, the direct rental expenses and your personal expenses that are not deductible now (but might be later, if you move out and rent your unit).

So while you don't need formal bookkeeping, you do need a way to keep those expenses organized - kind of like how you do for your charitable contributions or other specific tax deductions.

As for your questions:

-Would non-structural improvements to the unit I'm living in (I.e. updating appliances, flooring, etc.) be on a reduced depreciation schedule, or would it all fall under the 27.5 year schedule of the property? And would that schedule just take off the time I've lived there (26.5 year depreciation if lived in for 1 year)?

Expenses related to your portion of the building are not deductible and nothing is depreciated while you're living in it.  That includes appliances, rehab expenses and, most especially, your portion of the building.  

After you move out of the building, then your portion of the building begins its own 27.5 year depreciation schedule.  You'll essentially have two depreciation schedules.  You'll also be able to put any appliances into service based on their market value when you do so.  So if you buy a $5000 appliance suite now and then a year later you rent out your portion of the building, you'll need to know the fair market value of the appliances when you put them into service, then start depreciating them over their useful life from there.

Same goes for any major rehab/improvements you did to your unit.  You'll begin depreciating that after you move out and put the unit up for rental.

-Would the purchase of tools/equipment/materials used to perform work on both sides of the property be split by a %, or would that be fully depreciable under my business?

Tools that are needed for property maintenance, such as a lawnmower, ladders, etc would be considered common usage items (as per item c above that I mentioned).  Small tools that are commonly owned by most people (screwdrivers, hammers, etc) would generally be deemed as personal usage items.  But if you did have to buy a special tool specifically to fix a rental problem - like a pipe wrench - a case could be made for taking at least a partial deduction on it for the rental, if not a full deduction.  

-Are major capital expenditures (namely roof, furnace, ac, water heater) considered improvements even after they are past their rated lifespan? What if one fails?

Determining capital improvement vs repair is both an art and a science and is too involved to go into here.  There are specific guidelines published by the IRS to help guide you through this, but your real estate specialized CPA should know this and should ask the questions necessary in order to make the correct determinations for you.

-Would it be more beneficial to take care of these capital expenditures after I've moved out?

Possibly.  If you wait until you move out, you'll likely have more that is immediately deductible as well as getting the full value of depreciation rather than fair market value after you move out.  But then you're living in a place that may be falling down around you (figuratively, not literally) and possibly pulling your property value down as well as your ability to charge top rent for the other units.

Best of luck to you!