13

Let's assume:

  1. Boyfriend (bf) will be purchasing a 1MM condo in San Francisco, CA. Borrowing 750K from the bank.
  2. Girlfriend (gf) lives on the property with boyfriend. GF will be paying rent.

Accountant claims that condo property tax can be written off as this is a rental property.

Questions:

  1. Is this true?
  2. If so, can this be applied to bf's W2? Or will it only be applicable to rental income?
1
  • So many good answers! This forum is fantastic!
    – Tinker
    May 21 at 0:02
13

The rent paid can be offset by expenses related to renting. Assuming the girlfriend is effectively renting half the condo then the rent she pays (which counts as rental income for the boyfriend) can be offset by half the deductible expenses.

Those expenses include depreciation, property tax, mortgage interest, homeowners insurance, repairs, utilities, condo/HOA fees, etc.

If half of those expenses exceed the rent income received then the difference is your rental loss. Since you actively participate up to $25,000 of rental loss is deductible (meaning it can offset ordinary income from your W2) if your modified AGI is under $100,000. The maximum deductible rental loss phases out, so if your modified AGI is over $150,000 you can't deduct any rental loss. The exception is if you are a real estate professional, in which case you can deduct all losses regardless of income.

Losses that you can't deduct aren't necessarily wasted, they can be carried forward and potentially used in the future.

When you rent a property it is expected that you deduct depreciation expense, depreciation is re-captured when you dispose of the property, and renting adds complexity to a tax return (though fairly easily managed via modern tax-software). Many people opt not to charge their significant others rent when living in the same house, but instead share living expenses in other ways like paying utilities directly, buying groceries, etc.

You can collect rent and not record the income/expenses if it is not for profit, this requires that you be renting below fair market value.

2
  • So, if your net rental income after losses is negative, can it offset other earnings as well? If it does, would you be able to deduct those costs from your income if you weren't renting it to your girlfriend?
    – nick012000
    May 20 at 4:24
  • @nick012000 It wouldn't be phrased like that, it's rent received (revenue) - expenses = net rental income/loss. But yes, within the limits mentioned above up to $25k of those rental losses offset your other income, or if you're a real estate professional all of your losses can offset other income. That's for renting to anyone assuming you're doing so at fair-market value (different rules apply if you were cutting a friend/family member a great deal).
    – Hart CO
    May 20 at 14:15
7

This is sort of true, but it will only benefit the accountant. First you will have to claim the GF's "rent" as income, then you will have to track expenses etc. The GF will receive no tax benefit from renting.

Depending upon the rent paid, this could result in an income gain or loss to the BF. If a gain, additional tax liability will generated. If a loss you are opening up yourself to an audit that will like result in penalties and back taxes.

In a similar situation my accountant recommended neither claiming the income or expenses. We were renting to an elderly relation for less than the cost of the condo.

One thing will result is additional paperwork for the accountant which means additional fees.

I think it is wise that the GF is renting and not co-owning but not to take deductions based upon it. You may want to find a different accountant as this one does not have your best interest in mind.

2
  • 1
    Good point about renting not for profit, OP would just have to make sure to collect less than half the fair-market rent for the condo.
    – Hart CO
    May 19 at 14:23
  • 3
    "If a loss you are opening up yourself to an audit that will like result in penalties and back taxes." For context, many rentals generate paper losses due to depreciation, while rental losses may increase your odds of being audited an audit is nothing to fear if you keep decent records and aren't trying to cheat on your taxes. I wouldn't jump to the conclusion that the accountant does not have their best interest in mind, but it's good to point out the perverse incentive/conflicting interests in situations like this.
    – Hart CO
    May 19 at 17:45
1

Basically, BF can claim half of the property tax is being "passed on" to GF. That is, if GF is paying rent to him, and he claims that as income, then he can claim that a portion of what GF is paying him is not really rent, but reimbursing him for half of the property tax, and thus deduct that from the rental income. However, this requires that he claim the rent as income in the first place. BF should have a discussion with an accountant/tax professional whether not having rent as taxable income is possible (for instance, can have GF pay half the mortgage, and would that be treated differently than rent?) He should also consider whether he's willing to forgo collecting rent if it saves GF more than it gives him in after-tax income (and investigate whether that would have tax implications).

1

In addition to other answers: if the 'rental' property ever gets sold, not only is the gain now taxable income (compared to being free when not rented out), also all the depreciation becomes suddenly taxable income.

An example in numbers:
After ten years the 1 million property is depreciated to 700k (which is where the main tax gain came from), and then sold for 1.3 million. Taxable gain is 1300 - 700 = 600k, means probably 250k in taxes are due. Without the 'rent-out-trick': the 1.3 million are yours, no taxes due.

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  • How are there no taxes due in the second case? OP is a single individual with a girlfriend. A single person has an exclusion on the first 250K of capital gains on their primary residence, so in your example they'd owe tax on 50k, unless you're projecting they will be married by the time the house is sold? Even in the first case, the tax would be on the same 50k of gain plus 300k of depreciation recapture, not 600k, unless you believe this scenario does not pass the eligibility tests for primary residence for the 250k personal exclusion in Pub 523?
    – user662852
    May 20 at 5:21
  • What about a 1031 exchange? also, does the $600k tax at salary rates, or does it tax at long-term capital gain rates? May 20 at 18:03

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