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Tax Deductions for Owner-Occupied Rental Property

Owner-occupied rental property gives you access to two different pools of potential tax deductions...

As a home buyer considering an owner-occupied rental property here in Silicon Valley, you should know that you have access to two different pools of potential tax deductions. The part of the property that you occupy is treated as your house, and you can write off anything that you'd write off on a single-family residence. The rental part is treated as a separate investment property, which means that you'll need to file Schedule E to claim expenses related to it.

One important consideration is how to allocate expenses between your unit and the rental unit or units. For example, you can deduct your unit's pro-rata share of the property's mortgage interest and property taxes on your Schedule A form. However, if you don't itemize your deductions, you won't be able to claim them. The remaining interest and property taxes can be reported on lines 12 and 16 of your Schedule E, regardless of whether or not you itemize your personal deductions.

Another deduction you can claim as a rental property owner is for operating expenses. The IRS allows you to deduct everything you spend as an operating expense on your rental units, as well as a pro-rata share of what you spend on the entire property. So, if you pay for a repair in the rental unit, you can deduct the entire cost of it. If you pay for a utility bill for both units, you can deduct half of it, since half of the bill is for your personal use and half is an operating expense for the rental unit.

Depreciation is another way to claim a portion of the value of your rental unit as an annual deduction. To calculate your depreciation, you need to divide the value of the building, but not the land, by 27.5. Multiply the total annual depreciation by the share of the building dedicated to rental activities to find the allowed annual depreciation that you can write off on Form 4562 and on your Schedule E.  If you rent out half the home to roommates or Airbnb guests, you can claim half that amount.

Finally, it's important to know the tax treatment of sales for an owner-occupied single family with maybe an ADU. When you sell, the half that you live in gets the same tax treatment as any house, including the ability to enjoy up to $500,000, if you are married and filing jointly, of tax-free capital gains. However, the investment half of your home is subject to capital gains taxes and to depreciation recapture taxes. Keep this in mind when considering your long-term plans for the property.

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