In 1991 they added an enclosed patio behind the 2nd bedroom (190sf) which has since been converted to a master bedroom without permits but done professionally. 

if you meet this criteria, then you report the interest earned as ordinary income and deduct your expenses against it. 

Cost=125k.  62.5% of sales price Profit=75k     37.5% if sales priceFor all Principle payments rec’d;62.5% is return of basis, no tax37.5% is profit, taxed as ordinarybincome (flip income) us probaly self employmentInterest rec’d, taxed as ordinary incomeAs far as I know......

I basically plan to never sell or realize the gains, other than those from income generated through ordinary operations.

Nothing out of the ordinary. 

@Andrew PostellFYI:  flips are taxed as active, ordinary income, NOT as short term capital gains. 

Won’t start selling for a year so capital gains tax 20% versus if we sell within one year ordinary income of 38%.Could do many 1031 exchanges but would rather pay the tax and move on.  

So it was a $4000 per MONTH swing in our income.I'll send you a PM with some contact info for some great agents that actually understand investments and house-hacking and not just "wow, what a pretty patio!

Hi Julie,Passive loss can be used to offset ordinary income if your income is under threshold. 

If the net of the rental income and expense is a loss, you can deduct the loss against your other passive income without limitation or ordinary income ( w-2) with limitation.