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I live and own my own home with a mortgage. My boyfriend lives and owns his own home with a mortgage. We do not live together. Can I theoretically rent his home from him and he rent my home from me as tenants and can we each write off our properties as rental properties?

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  • 7
    What country are you in? Tax laws differ from place to place
    – littleadv
    Apr 21 at 21:59
  • 17
    Relevant XKCD (replace "insurance" with "tax").
    – Trang Oul
    Apr 23 at 7:13
  • Live in the USA
    – ALG
    Apr 24 at 22:43

1 Answer 1

17

You will have a few issues.

The rent is income; but you can count the interest, taxes, insurance, HOA fee, and repairs as expenses. The principal doesn't count as an expenses. If you weren't able to itemize before, then this ability to count interest, and the other things could be a help.

There is good news and bad news about the depreciation. This should wipe out any income you would have had left because of the inability to count principal as an expense. The bad news is that when you eventually sell the property or turn it back into a non-rental the IRS will want to recapture the depreciation - there will be taxes.

If you just bought the home the mortgage company might not be happy you aren't living in the property. You may have signed paperwork that you would live in the home. If the mortgage is a couple of years old, they won't care.

You will have to move. You will have to change your drivers license, and everything else to that address. You should also move all your stuff.

What happens if you breakup?

You should have a lease, to prove this isn't a way to fool the IRS.

The bigger issue will be, does the IRS consider this a step transaction

Courts have applied three alternative tests in deciding whether to invoke the step transaction doctrine:

  • (1) the "end result" test, under which the transaction will be collapsed if it appears that a series of formally separate steps are really prearranged parts of a single transaction intended from the outset to reach the ultimate result, see King Enterprises, Inc. v. United States, 418 F.2d 511, 516 (Ct. Cl. 1969);
  • (2) the "mutual interdependence" test, which focuses on whether "the steps are so interdependent that the legal relations created by one transaction would have been fruitless without a completion of the series," Redding v. Commissioner, 630 F.2d 1169, 1177 (7th Cir. 1980), cert denied, 450 U.S. 913 (1981); and
  • (3) the "binding commitment" test, under POSTS-153917-06 2 which a series of transactions is collapsed if, at the time the first step is entered into, there was a binding commitment to under take the later step

So if the IRS sees this a step transaction, then any tax savings would be wiped out.

Talk to a tax lawyer.

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  • Better answer than mine. I suspect the answer is that by the time you do this safely and correctly there's no advantage, but that's why one should talk to experts about specifics rather than asking the Internet about generalities.
    – keshlam
    Apr 21 at 23:56
  • 7
    In the US, it's actually even worse than that. Depreciation recapture is taxed at 25%, which I suspect is higher than the effective rate for the OP, and is definitely higher than the cap gains rate. It also comes before the primary residence exclusion, so it makes something that could have been tax free - taxable. Also, this arrangement eliminates the primary residence exclusion for both of them, or at least makes it significantly less useful.
    – littleadv
    Apr 22 at 0:50
  • Isn't total AGI relevant here? If it's over 150k, isn't this entire scheme a wash?
    – rtaft
    Apr 23 at 14:04
  • "You may have signed paperwork that you would live in the home. If the mortgage is a couple of years old, they won't care." In the UK they would as this would be a different class of mortgage (buy to let) attrating a higher interest rate.
    – deep64blue
    Apr 23 at 16:08
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    Layman's input here - in the UK when you eventually sell the property you also pay Capital Gains Tax on the increase in value of a property pro-rata for the proportion of the time it wasn't your primary residence (although it's a bit more complicated than that) so even if the month-to-month figures work out you have to consider what happens when you dispose of it in 5 / 10 / 20 years time.
    – mclayton
    Apr 23 at 20:28

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