My wife and I are thinking about purchasing a 2-unit building. We would live in one unit, and rent the other one out. The idea would be that down the road, we would convert the property to a single family home. We would purchase the property with a single mortgage.

I want to understand all the tax implications before moving forward.

From what I've read, rental income gets recorded on Schedule E, and I can take mortgage interest as an expense against that income. With a single mortgage payment for both units, how would I calculate the interest that goes against the rental property?

Would there be any tax implications when I decided to convert the unit from a rental property?

Finally, as a general matter, if the expenses for the rental unit (including mortgage interest) consistently exceeded the income generated, I would never have to pay taxes on the rental income?


The interest (and any other joint expenses) would be split according to the amount of the property that is rented. There are several ways of calculating the split. Probably the easiest would be by the square footage of each section. If both units are the same size, then a 50% split would be reasonable. You could also do it by the fair market rental value of each unit. You would want some documentation of how you came by the valuation.

Any expenses, including utilities, repair and maintenance, taxes, insurance, etc., can be claimed on Schedule E. The purchase cost must also be depreciated over time, along with some kinds of improvements (appliances, roof replacement, etc.). Deprectiation is basically writing off the expense over time, instead of all at once.

Not only can expenses offset rental income, but if they exceed the rental income, you can use them to offset other income, as long as you are under the income threshold ($150k). If your income exceeds this, the excess deductions accumulate, and can be used to offset rental income in future years, or when you sell the house. For the first year you file taxes, I would seek the help of a tax preparer. It is not overly complex, but there are a lot of details that you don't want to forget. After the first year, you can probably handle things yourself.

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