Mortgage Interest Deductions for Rental Property- Video
Bob Weaver, CPA: Interest expenses. This is a popular misconception. I’ve seen plenty of folks make mistakes here. You may think you know what the answers are here but some of you don’t. We have the rental entry on a rental. We have interest deductions, we have purchase money interest. That’s all is deductible is right rental expense. If you get a loan on a property that you’ve just bought. You bought it with that. The interest on it, that’s going to be deductible. There are going to be some limitations on it, but generally, that interest is deductible. We have equity borrowing on your residents.
I’ve seen a lot of people borrow money on their residents and tried to deduct the interest on the borrowing on your resident, when you take the money out and you go buy a rental. Guess what? That’s deductible as well. We have some options there. We can deduct at least interest on $100,000 as primary residence address and we get to deduct the rest on the rental or we can make an election to deduct it all on the rental. It depends upon whether you’re limited on your losses, as to whether or not we want to do that. Anytime you borrow equity on your residents to put into a rental property, we go through that calculation and we see what’s best for you.
Equity borrowing on a rental, what I describe with the home equity indebtedness and you borrow and we elect to trace it to the rental. That’s what we do. We elect to trace it to the rental. The equity borrowing in a rental, all you have is tracing only. If you borrow money on one rental because you’ve built up some equity and you go buy a property and I borrow on Property A to buy Property B, I deduct the interest. I trace the interest to Property B and deduct the interest on Property B.
Now, what I have seen is people borrow money on their residents, borrow on their rental and buy a house with it that they live in. Buy property that’s not a deductible rental. We’re going to trace that interest to the property that they just bought which happens to be their house. We can all deduct interest on our house, right? That’s true if the debt is on that house. I see people borrowing money on their rental properties to buy homes that they live in and they can’t deduct the interest. That’s an exercise. I’ve seen folks from this group that have done that and I’ve had to give them bad news.
I just wanted to bring that up. Don’t ever do that. Well, you can do it. If the economics are good, do that anyway, but you’re not going to get the deductions. Yes, sir?
RWN Member: Your last statements that for your own residents, you could schedule A that interest.
Bob: No, you can’t. Not if you borrow that money on your rental. No, you cannot, because any interest you deduct is an interest on your schedule A has to be secured by your residents that you live in. That is not secured by that property that you live in. No deduction. It’s as though you got out, borrowed money on your rental and bought a boat. Same concept. You bought something of personal nature, it’s not related to the rental, no deduction. That doesn’t mean you tell me about it… Just kidding. We never want to say that. Nobody from the IRS is here, is there?
Kathy Fettke: This being recorded.
Bob: Yes. Well, I was just joking, of course. Okay. Gentleman at the back brought this subject up is what he was alluding to. We have what called the passive activity loss rules, so this is the bad news but we have some good news here but we have some bad news as well. The passive activity loss rules, why some rental losses might not be deductible. I should have drawn a big sad face because this is– Especially in the barrier where you’re all considered rich because you make so much money because you have to make so much money just to be able to live here. These rules, by the way, haven’t changed since 1986.
How many of you aren’t making more money than you made 1986? These numbers get to be a problem because what can happen in the passive activity loss rules is your losses might be limited. First of all, we have this $25,000 exception. This $25,000 exception, we call these the mom and pop rules which means you’ve got mom and pop that own a few rentals. Congress was interested in allowing them to take their deductions, but mom and pop couldn’t have a lot of income. Back in the day the income limitations were $100,000 to $150,000 so on a 50 cents you got a $50,000 window here 25 to get rid of this $25,000. It’s 50 cents on the dollar so when I started 100,000 this is funny it’s for individuals or for married couples. You start losing this $25,000 as you get over $100,000 by the time you get $150,000 that becomes a big goose egg.
Certainly in this market so many of you are over this number on your other income because you haven’t quit your day job and done just rentals so you’re actually having W2 income, business income whatever it is, it’s pushing you over this especially if you’re married, two earners you have no problem getting over these numbers and you can’t deduct your losses so back when I was talking about ramping up the depreciation we’re not going to bother doing that for you because you’re not going to get a benefit for the deduction today. You’ll get a benefit of that deduction but it may be over time. This applies to all your rental activities.
There is a silver lining that I’ll talk about that I’ll get to in a minute called the real estate professional rules, but those are some pretty tricky rules. You’re allowed to offset though this is a global loss deduction limit meaning if you have income from property A and a loss from property B we’re not limiting loss on property B to the extent that you have income on property A. Let’s say you have a $10,000 income on property A a $12,000 loss on property B your limitation will be $2,000. You’ll be allowed to offset the entire income of property A but not take a loss deduction beyond that. Does that make sense?
Let’s say you have two properties, property A and property B. Property A generates $10,000 of taxable income so positive income $10,000. Property B generates a loss of $12,000. Your loss limitation is going to be $2,000, your net loss is $2,000. That’s why we put through this exception here to see whether or not you can deduct that $2,000. That’s what this is all about is to determine whether or not you can deduct that extra 2,000 your net loss from all your rentals. You could have $100,000 of losses offsetting $100,000 of income on multiple properties it wouldn’t be a problem but when you get to the point where you have a net loss for the whole group then we run them through this limitation.
Now, you’re not going to lose those losses but you are going to be limited. Again if you had passive income from other sources this isn’t just real estate this is any kind of business, any kind of investment, not interest in dividends, not capital gains per se but capital gains from the sale of rental would be passive income. Often times when we have a rental that we sell and we have taxes maybe we don’t do exchange because we have some carryover losses that we can absorb that gain because we have all these losses that we couldn’t use.
They pile up and they carryover to future years and so if I have that $2,000 a year on property B for the next five years I’ve got a $10,000 loss carryover but when I sell property A and have a gain I’ll be able to use that 10,000 against the gain on property A. Or if I sell property B the loss gets used when property B is sold, any accumulated losses that you’ve had doesn’t matter whether you have a gain or loss on property B any loss carryovers you had there are related to property B and yes we accountants do have to keep track of all this. They will give you the credit for those losses on property B at that time.