Tax Treatment Of A Second House?

jyl · jyl's Garage

My aged and widowed mother-in-law (who will also be referred to as "the aged relation"), in poor health with heart problems, sold her house and moved into a rented townhome in a retirement community. The owner of the townhome passed away, and her children decided to sell the townhome. This would have displaced the mother-in-law, very traumatic for an older person.

So my wife and I, and my wife's sister and her husband (hereafter referred to as "we") are going to buy the townhome and rent it to the mother-in-law. We negotiated a price that will permit the mortgage to be pretty close to the mother-in-law's existing rent, and we will eat the monthly difference as well as maintenance, insurance, etc. We found a loan that works and is straightforward, 30 yr fixed, we had to jack up the downpayment up to mke it affordable for the aged relation, ouch. (Thank you to someone on PPOT for giving me advice on the financing, you know who you are.)

The townhome will not be in the mother-in-law's name, to avoid complications with her other children when she passes away. My brother-in-law had his attorney set up an LLC to hold the townhome, and my brother-in-law will handle the record-keeping for the property (he lives in the same town and the aged relation, I live 3 blessed hours away). Things seem pretty much on track so far. My brother-in-law and sister-in-law are 110% trustworthy and competent.

Here is my question. What is the tax treatment of the mortgage interest and maintenance costs for the townhome? Is any of it going to be deductible to me, and if so does that still apply under AMT? To be clear, this is not my primary residence, not even my second or vacation house, perhaps it is technically an "investment property" although we don't wish to own it, will have negative cash flow from it, and all involved intend to sell it promptly, likely at a loss, after the mother-in-law passes away or otherwise can no longer live there.

I hope someone tells me that this can at least help my tax bill a smidge.

legion · 04-03-2007, 06:58 PM

IIRC, your primary residence, in which you reside, is the only one you can deduct interest expenses on. However, there might be other tax advantages out there. I know some others on this board own rental properties. I hope they chime in.

turbo6bar · 04-03-2007, 07:26 PM

As far as I know, the LLC will pass income, expenses, and deductions on to the members. You will have to decide the proportions with your partner.

You are certainly entitled to write off interest expenses, as well as all expenses, but you'll also have to declare rental income. In the end, you'll likely show a paper loss due to depreciation.

Can't help you with regards to the AMT issue.
regards,
jurgen

berettafan · 04-03-2007, 07:33 PM

you need to cough up for a good cpa.

You will be reporting the income and deducting related expenses on the LLC return (assuming more than one member). you will also be depreciating the house. you do own the house via ownership of the LLC. net income or loss will pass through to the members via K1. in short, the house is an investment property.

be sure to set up a bank account in the LLC's name and treat it like the business it really is. also be sure you are 50% of the LLC (assuming your intention is to own 1/2 of the house) and also be sure to have your own atty or cpa review the articles of organization for you.

the only issue i see here is one of a 'related party' and whether the rent you collect is market rate or below. don't want to elaborate on that without researching. most likely a non-issue.

i can follow up in the am if noone has answered for certain regarding the related party issue.

fintstone · fintstone's Garage

Don't know about an LLC, but you can normally deduct the interest and taxes on a second home but only taxes on the third.

Moneyguy1 · 04-03-2007, 10:27 PM

What if it is treated as a business investment?

How are the "Other children" involved? One might inquire about a "life estate" situation with you and your brother-in-law named as remaindermen.

Just thinking out loud....

gr8fl4porsche · gr8fl4porsche's Garage

You have not purchased a second home - you started a business. All expenses except for improvements (a very grey area in the rental business) are deductible. As stated above you have to claim rental income or loss and are allowed to depreciate the asset. A seperate tax return has to be filed for the LLC. I am not positive, but I believe you can deduct your portion of the loss on your tax return.

berettafan · 04-04-2007, 09:34 AM

Passive losses, which this would be, are deductible vs. passive income entirely and vs. non-passive income up to $25k in loss. This $25k in allowed loss vs. non-passive income is phased out as AGI climbs.

jhc · 04-04-2007, 01:35 PM

No loss allowed if joint adjusted gross income is above 150k. You get to carry forward your losses and deduct from profit when you sell.

turbo6bar · 04-04-2007, 05:12 PM

I would use HUD fair market rents to determine market prices, and if that does not produce a satisfactory number, survey actual rental prices in the area. The IRS wants to be sure you're charging market rates.

jyl · jyl's Garage

Hmmm. Thanks all for the answers. I will explore all those angles, though I'm not seeing a lot of tax benefit for me. I think I shall have to propose to the wife and in-law siblings that we remorselessly raise the rent for the aged relative until we extract the last dollar of savings. Would that be bad karma? Okay, never mind. I'll think of this as the price of not having to build an in-law apartment for her in my basement.