Starting with your 2018 tax return, you’re going to see a lot of changes. If you currently itemize your deductions, you’re likely to find that you are going to have a whole lot less of them.
One change that is hitting a lot of people, especially if they live in an area that has high property tax, is the maximum amount of state tax and property tax that will be allowed for deduction. The total is $10,000, combined for state, local and property tax. There are some places in the US where $10,000 per year for property tax isn’t enough for a middle class home. And that’s before you add in your state and local taxes.
If you really want to keep the deductions, you’re going to have to get creative and do things a little bit differently.
One idea is to rent out part of your house. For example, let’s say you rent 50% of your house. You’ll probably have to share the kitchen and maybe some other public space, so it does mean a change in lifestyle.
But, look what happens to your taxes.
Since you rent half you house, half of your regular expenses are now rental expenses, not limited itemized deductions. That would mean 50% of your mortgage interest, 50% of your property tax and probably 50% of utilities and other expenses.
These are all now reported on your Schedule E and are fully deductible. Since your property tax that is personal is now cut in half, chances are it will be fully deductible on Schedule A (itemized deductions) as well.
There could be a couple of things to note, though, with this plan. First, you may end up with a loss on the rental property. Unless you otherwise qualify to take real estate losses against your other income, the loss will be suspended until a future date. The ideal situation, if you can’t take that loss, would be to receive enough rental income that it is exactly offset by the expenses.
You can also take depreciation on 50% of the depreciable basis of your property. However, when the property sells, the depreciation must be recaptured and it’s taxable.
And finally, if your property sells at a profit, you’re going to lose the capital gains exclusion for your primary residence. The rule says that if you live in your home for 2 of the previous 5 years, you can exclude $500,000 of gain if you’re married, filing jointly or $250,000 if you’re single. If half of your house is a rental and it won’t qualify for the 2 out of 5 years rules, you will pay tax on that part of the gain. If that occurs and you have suspended loss from the rental, it can be used to offset the taxable gain.
The best strategy to retain the primary residence capital gain exclusion is to live in your home for 2 of the previous 5 years. If you know you’re going to sell and the gain will be big, maybe it’s time to kick your renters out and live in that side of the house again for 2 of the previous years.
None of these are strategies engraved in stone. They won’t fit every person in every situation, but maybe it will get you thinking about other possibilities.