Rental income expense or personal income deduction? Can I pick?

Question

We own a duplex in California. We live in one part and rent about 1/3 of the property as a separate apt. On our federal taxes return, we take 1/3 of our property taxes and mortgage interest as rental expenses, and the remaining 2/3 as Schedule A deductions off our regular income. It is my understanding that this is the ordinary way of assigning these expenses and deductions.

With the expenses in Calif of mortgage interest and property taxes, we are showing a net loss on the rental income. However, as our adjusted gross income is over $150,000 we cannot take this passive loss against other non-passive income sources, so it is carried forward until we have a profit we can subtract it from.

My question is: can I take the entire mortgage interest and prop tax payments as personal income deductions, rather than rental expenses? That way I will see some immediate reduction in my taxes, versus some future tax reduction for my rental profits.

Is this “legal,” or even sensible?

Answer 1

I'm not a tax expert, but in reading your question I would suggest you look at two additional factors in your tax situation which may return more of your lost tax dollars than the issue involved in your original question. First, double check the IRS' rules on passive investment--in your situation you may be an active investor. Secondly, your brief discussion of your situation mentioned nothing about depreciation. I believe this is an aspect of your situation which both in terms of yearly as well as long term taxes might be as important as any mortgage deductions you take.

Answer 2

I've worked as a tax preparer- not many clients have this issue. So i would say play around with the situation and c which situation fits best. I would just use 1/2 on Schedule E and the other part of the mortgage and tax on personal deduction on the Schedule A. Now what u put on Schedule E will transfer to the schedule A also. But calculations will make ur outcome differently.

I hope i got u some what an i ideal....if not-SORRY!! :)

Answer 3

You are obviously very well read in taxes and asked a really good question. In my mind, I went back and forth between it being legal and illegal. I had to consult www.irs.gov to resolve it.

Even though it would make sense for you in the short term, it is probably illegal. IRS Publication 527 says, "How to divide expenses. If an expense is for both rental use and personal use, such as mortgage interest or heat for the entire house, you must divide the expense between rental use and personal use."

I can see how you will be willing to forgo future passive losses for current Sch. A losses, but it looks like this is not when the IRS wants you to do. Good thing is, no matter what your income level, when you sell the property, you will be able to write-off any unused losses that year. You'll need them too, because you'll most likely be recapturing a lot of depreciation.

Hope this helps :)

Answer 4

I am an income tax professional, but I shouldn't mention the well-known firm for which I work. You are right, and well-spoken I might add, about many things. You own the property, and you can deduct the mortgage interest and property taxes on your personal return. You should file a Schedule E for your rental expenses, which will include maintenance, repairs, upkeep, that sort of thing. You should show a profit in this way, and deduct your carried-forward losses.

Answer 5

I concur with taxman on this one. You are not an "active" investor since real estate rental is always passive unless you are a "real estate professional" Save your losses up for the sale or your income dips.