The Tax Angles

Uncle Sam allows homeowners to prorate the following costs of being a landlord:

• Utilities
• Homeowner’s insurance, along with related riders and policies
• Depreciation
• Property taxes
• Property maintenance like exterior and interior painting and landscaping costs

The deduction depends on what percentage of your house you rent out. For example, if your home has a full basement that’s rented out, you’ll be able to deduct half of your expenses. Or if you have a 2,900 square-foot home and rent out 800 square feet, your deduction will be 28 percent.

First, Check Out the Town Zoning

Your first move should be a call to the town zoning department. In most subdivisions, zoning laws limit houses to single-family occupancy. That doesn’t mean you can’t take in a boarder or two, although that may violate local ordinances. If the tenant is a relative, you shouldn’t have a problem with adding an in-law apartment. Most zoning departments, insurers, and mortgage lenders will go along with that kind of addition.
But if you want to create an apartment and rent to a nonrelative, check the zoning first. If that is prohibited, you may be able to get a conditional use permit or variance. This entails going to the zoning department and filling out the paperwork. There may be restrictions on how utilities are set up as well as inspections for building code compliance. A hearing may also be required to give the neighbors a chance to protest.
True, this is a more expensive and time-consuming way to go, but in the end it’ll be worth it. Some homeowners ignore zoning rules because the city or county is lax in enforcement, and they know they can get away with it. They possibly can for a while, but it usually comes back to haunt them. Administrations change, and all properties are eventually put up for sale. If they sell or refinance, a mortgage lender may want to see the permits. Or the insurance company may deny a claim if you’ve violated the policy terms and your home is now a pile of ashes.
Also, if you’re buying a home with an apartment, garage, remodeling, or addition, you’ll want to verify that building permits exist and the house is zoning compliant. Otherwise, you can end up with fines and expensive upgrades. You can also get extended title insurance coverage at closing that insures the previous owners have complied with all zoning and building permits.
Brandon and Julie had this problem when they made an offer on a home with a basement apartment in a great neighborhood near a university. The apartment had been rented out for years, and several other homes on the street also had basement apartments. No one questioned whether it was zoned for a rental. However, when the appraiser checked the zoning, she found it was zoned for single-family homes and adjusted her appraisal down.
Although the city zoning department said it hadn’t and wouldn’t enforce the zoning in this case, it still wouldn’t approve the house and apartment for duplex zoning.
This created a sticky situation. As a single-family house, its appraisal came back $12,000 under sales price. The sellers were upset because now the genie was out of the bottle and the home couldn’t be sold as a duplex, lowering the value considerably. And no mortgage lender would finance an illegal duplex. The buyers, rather than walking away from the deal, offered to buy at the reduced price, and reluctantly the sellers accepted.
The bottom line is that before you buy a house with an apartment, check the zoning and verify any required permits. It can save you costly tax, insurance, and zoning headaches later on.

Turning Extra Space Into Tax Breaks and Income

When Sharee divorced, she ended up with the house and a $1,900 mortgage payment. There wasn’t a lot of equity, so selling was not an option, nor was letting the home go into foreclosure and ruining her credit.
The home had a finished basement with an outside entrance, two bedrooms, a family room, full bath, and a wet bar. Sharee figured she could easily covert the wet bar into a kitchenette and rent the basement for $800 a month.
The practice of renting extra space in the attic or basement has spread to more affluent urban areas as well as suburban neighborhoods. Empty nesters, one-income families, widows, and widowers are taking in tenants to help pay their mortgages. Others are adding basement or attic apartments when they build a new home. If you’re anticipating caring for parents or kids who may come home the second time around, consider adding a finished apartment. If that’s not feasible, at least add the electrical and plumbing rough-in. This is a lot cheaper than retrofitting later on.

Look Before You Leap

There’s also a downside to creating a home office. Eventually, you’ll probably move, and if you have spent $20,000 to create a great home office, chances are you won’t be able to add that to the price of the home. It may even lower the value.
Before you draw up plans and get bids for that dream home office you saw in a magazine article, do some ‘‘what if ’’ thinking. If you’re planning on moving in a few years, will the home office add to the sales appeal? If you turned a bedroom into an office, can it be restored back without too much trouble or expense? Look at other homes that have sold in your area. What will be the biggest sales attraction, a bedroom or an office?

What You Can Deduct?

Depending on the percentage of your home you use for business, you should be able to deduct portions of utility bills, mortgage interest, repairs, depreciation, cost of a second phone line, office equipment, and any other related expenses. You may also be able to depreciate computers, equipment, and office furniture. However, it’s important to set aside the area you use for business. You can’t put a filing cabinet in the family room that’s used for watching TV and call it an office. The area must be used for business only.
If you decide to claim a home-office deduction, you should keep meticulous records of all your expenses and be prepared to back them up if you’re asked to by the IRS.

Tax Advantages of Working at Home

Thanks to broadband technology and laptop computers that rival desktops, more people can work at home and leave the commuting to the rest of the world. To make this a more viable working option, Congress passed the Taxpayer Relief Act of 1997, which contained a modification of the IRS definition of principal place of business. Beginning in 1999, the new rules allow those who don’t have offsite office space to deduct the expenses of a home office. Contractors, sales reps, consultants, and others who perform their services outside their office but need a home office can benefit. However, you must use the office exclusively and regularly for business. In addition, if you use part of your home for business such as paperwork, store records, inventory, or samples, you may be entitled to a deduction. You can also convert or build a separate structure that’s not attached to your house. Detached garages, carriage houses, sheds, small barns, etc. make great home office conversions.

Renting vs. Buying Tax Comparison

To get an idea of exactly how much you would save buying a home versus renting, let’s assume that a renter and homeowner both make $60,000 a year.
The renter pays $1,000 per month rent and gets no tax breaks. The homeowner has a $140,000 mortgage at 7 percent, with a $1,100 per month payment. Real estate taxes are $1,500, and mortgage interest paid for the year totals $9,756.
To keep it simple, assume that both renter and homeowner are in the 25 percent tax bracket. The renter will owe .25 _ $60,000 or $15,000 in taxes to Uncle Sam.
The homeowner will be able to deduct the $9,756 interest plus the $1,500 in property taxes paid, or $11,256. Subtracting that from the $60,000 income leaves $48,744. Multiplying that by the .25 percent tax bracket leaves a tax bill of $12,186. Dividing that by 12 months translates into a savings of $235 a month.
The homeowner’s after-tax monthly house payment ends up at $865. And after 360 payments, the homeowner gets to keep the house, which should appreciate significantly.
The renter will have a stack of rent receipts and the uncertainty of rents going up whenever the economic winds shift. Your tax situation may vary, but a useful rule-of-thumb is that you’ll save about 20 percent of your monthly mortgage payment in taxes. Talk to a tax professional to see exactly what you’ll save and what mortgage payment option will work best for you.

How Tax Deductions Work?

In most cases, homeowners are able to deduct the amount of mortgage interest paid in the tax year as well as property taxes. When you sell the house, you don’t have to pay capital gains tax on the first $250,000 for a single person or $500,000 for a married couple. Obviously, the financial deck is stacked in favor of home ownership. Ron and Laura took advantage of this exemption when they both retired and sold the home they had lived in for 23 years. Their $62,000 home had appreciated to $219,000, and when they sold, everything was tax-free. They bought a motor home with half of the proceeds and banked the rest. After closing on their home, they drove out of the title company’s parking lot in their new motor home and off into the sunset. If they had been renters, there would have been no motor home, no $100,000 bank deposit, and no driving off into the sunset.

Tax Aspects of Buying and Owning a Home

One of the big reasons for buying a home is the tax break. Uncle Sam, in effect, subsidizes your mortgage. Couple that with the consistent appreciation of homes, and you have a financial advantage that’s hard to ignore.

Another important tax aspect is property taxes. You pay them indirectly when you rent because the landlord includes them in the rent. If your landlord’s building is reassessed and the taxes increase, your rent will go up either next month or at the next lease renewal. In this sense, landlords don’t pay taxes, the tenants do. Anytime taxes or other costs go up, the landlord has no other choice but to pass these costs on.

Unfortunately, there is no escape from the tax man. But, at least when you own your home, taxes become an additional deduction. Still, you want to keep them as low as possible,