Taxes on investment real estate?

I'm thinking of buying a 2-unit building, using one unit as my primary residence. My question has a few parts.

1) I'm planning on moving out of my townhouse and renting it out full-time. I can easily get $1500/month for that. How will that income be taxed? And how will that affect my taxes at the end of the year? Will I still get the tax break for the mortgage interest that the renter pays?

2) I'll be moving into the 2-unit building, using one of the units as my primary residence. I can get $1500/month for the other unit. How will that income be taxed? And will I still get the tax break for the mortgage interest that the renter and I pay towards this second mortgage?

I'm still maxing out my 401k each year, to take advantage of that tax break and help plan for my future. So that'll help out each year.

Any help you can offer will be greatly appreciated.



Thanks!

Answer to Question #1:
Talk to a CPA for sure. However, your income will be taxed based on all adjustments to income and deductions from income that yield your taxable income. For rental property, you file a Schedule E with your 1040, where you summarize rental income and deduct expenses. Your mortgage interest can be deducted on EITHER the Schedule E or the Schedule A. Up to a certain threshold of income, it will be easier to deduct on Schedule A, but a CPA can help with that. IT's worth paying the CPA and you can deduct their fees on your Schedule A OR the Schedule E. So, yes, you do get the tax break on the mortgage interest paid by the renter on ALL properties that you own.

Answer to Question #2:
Same as Question #1. You just need to track the income and expenses for each unit separately. Make sure to not commingle expenses for the unit you live in with the unit you will rent. Get help from a CPA on how to properly separate and account for the expenses, as some may not split easily (HOA fees, property taxes, roof maintenance, etc.)

Finally, good for you for making these investments. The knowledge you gain will be as valuable as the profits you receive.

Good luck!

Renting is an attractive investment because you pay income tax on any profit but not capital gains tax (unless you sell the property.)

You are allowed to itemize mortgage interest on Schedule A of Form 1040 only for your primary residence, that is the one you live in. Therefore, mortgage interest you pay on your townhouse will be an expense used to reduce your rental income, but cannot be itemized on Sched A.

Because maintenance, repairs, property taxes, interest, and depreciation are all expenses that offset your profit from renting, you may show little or even negative cash flow when renting. You are required by IRS rules to pay tax on any depreciation taken once you sell the property.

My advice: Keep very good records. Do not attempt to do your own income taxes, even with software like TurboTax. Consult with a tax professional or CPA to determine if you will need to pay in quarterly to the IRS and your state.

Besides talking with a great CPA or CTP (certified tax preparer) I would look into doing 1031 Exchanges to help with the tax deferment. Make sure you itemize well, and know what your property is worth. This will help you to calculate the proper rental income amounts for the property you plan to rent out. Since you will be living in the second home after living in the first one prior to renting it out, I believe you would benefit using the 1031 Exchanges.
Congratulations on your investments, good luck to you.