Buying my parents home and renting to them, need tax advice :)

[Joe Wentworth]

I'll keep it simple, their credit is not good, mine is great, I have my own home and have amazing credit, they have first and second mortgage on theirs at high rates and cannot refinance due to lack of income (one stopped working). I would like to buy their home at current market value + 20k or so to pay off their other debts (so no bank thinks it's something shady, home appraisal would confirm this value) and then rent it to them at basically what the new mortgage at low % is.

I have no idea who to speak to about paying taxes on income or where to begin, Their home needs some renovations so I would also like to write those off as I do them.

Are income taxes paid on rental income when I'm renting at a loss? lets say I rent for $1000 and the mortgage is actually $1200?

What should I do to pay as little as possible to the gov? :) (LEGALLY) and still end up saving my parents a bundle, just running basic numbers I'm looking at $1200/mo savings between their first+second mortage vs. what new one at 4% would be!

Thank you in advance for any generic help you can give me, just please point me in the right direction.

[Jon Holdman]

The taxable income from the rental is the rent you actually collect less all your expenses. That includes money you pay out, such as insurance, taxes, and interest. Those are three parts of the payment (PITI - principle, interest, taxes, and insurance). Note that the principle part is not deductible. You can also deduct anything else you spend, such as maintenance. You can also deduct depreciation. Depreciation on a rental property is the value of the improvements (not land) divided by 27.5 per year. For the partial year when you buy the property, its just the portion of the year you own it.

If your PITI is $1200 and you charge them $1000 rent you will have negative taxable income. That's a "passive loss". That means you will not pay any taxes on the rental income. Depending on your AGI, you may be able to offset some of your other income with that loss. If your AGI is under $100K, you can take up to $25K per year of passive losses against other income. AGI over $150K and you can't. In between in phases out. Doesn't matter what filing status you use, limits are the same.

The renovations are a little tricky. Normally, any money you spend before its rent ready would go into your basis rather than being deductible in the year they're spent. But I assume your folks would just stay in place. So, its rent-ready the day you buy. Any money you spend on maintenance would be deductible in the year you incur the expense. That said, capital items (e.g., roofs, furnaces, carpets, etc.) must be depreciated over multiple years. For example, the IRS considers carpets to have a lifetime of five years. So, if you spend $5000 on new carpets, you have to deduct $1000 per year for five years, even though you spend the $5000 up front.

You will need a CPA who's knowledgeable about rentals. Forget about doing your taxes yourself. Its just too complex. You can fill out the forms with TurboTax or some such, but unless you really understand this business, you will miss stuff and costs yourself money.

This won't work. Appraisals are VERY, VERY conservative right now. Whatever you think market value is, you're probably overly optimistic. Appraisers (you CANNOT choose the appraiser) will choose the low end of the comps. If it needs work, they will knock the appraisal down.

Realize that you will be buying this house as an investor. That means 20-25% down payment, an investor rates 0.5-1% higher than OO rates, and you will have to fully qualify for this house and all your existing debt without any consideration of the rental income. The lender is going to scrutinize this pretty closely because its not an arm's length transaction.

Also keep in mind that selling the house creates a taxable event for your folks. Depending on what they paid for the house and improvements, and what they make on the sale, they may owe taxes. Now, they can exclude $500K in gains since its a primary residence they occupy. But, depending on the numbers, they may still have a gain. If they bought this 50 years ago for $50K and they sell it to you for $700K, they have a gain of $650K (less costs of the sale). Any documented improvements would come out of that, and the $500K comes off, too, but there may still be a gain. Note that any debt they have on the property is irrelevant for this purpose. Even if they owe $700K on the property they could still have a tax bill.