IRS Tax Provisions For Rental Property And Primary Residence

Added April 24, 2008 by Ilyce R. Glink

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Summary: What tax deductions can you take on a primary residence and on a rental property? The IRS does not let you treat a property rental as a primary residence for tax purposes. And what risks do you face if you rent out a property in a homeowners association that prohibits rentals?

Q: I have two primary homes but would like to buy another. A friend wants to live in one of my primary homes and pay me rent.

My question is: How do I structure this in order to deduct taxes/interest on all three homes? I was thinking of setting up a sole-proprietorship on my current home that's to be leased out to my friend. Also, if the homeowner's association does not allow tenants, can I get in trouble by law if I rent the property out?

A: No one can have two "primary" homes. The word "primary" means first. The home in which you live most of the time, is considered your primary residence. The other house you own is your second home, or perhaps a vacation home.

The IRS currently permits you to deduct the interest you pay on up to $1 million in mortgages and $100,000 in home equity loans on your primary and secondary residence. There are additional restrictions on these limits and these amounts are for married couples. Likewise, real estate taxes paid on a primary and secondary residence are generally deductible.

So, now you want to buy a third "primary" home. There is no provision in the IRS code for deducting the interest and taxes on a third "primary" residence. In fact, it sounds like you are about to start being an investor in real estate. If your friend starts to pay you rent, you can claim that property as an investment property. You'll be able to write off the expenses of owning the property (mortgage interest, insurance, taxes, maintenance, etc. along with other investment benefits) against the income you receive from your tenant.

The problem you may run into is with your homeowner's association. If the HOA does not allow rentals, and you rent out your home, you run the risk of being fined by the HOA, or worse. They could sue you for violating HOA rules. You don't want to go there.

What I suggest you do is sit down with a knowledgeable real estate attorney who can discuss these issues with you in detail and provide some sort of workable structure for what you're trying to do. For more details on tax deductions, please go to IRS.gov and read Publication 936 (http://www.irs.gov/publications/p936/index.html), Home Mortgage Interest Deduction; and Tax Topic 505 (http://www.irs.gov/taxtopics/tc505.html), Interest Expense. You may also find Publication 530 (http://www.irs.gov/publications/p530/index.html), Tax Information for First-Time Homeowners of interest as well.

April 24, 2008.

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