Expert: Dick Dennis - 1/18/2006

Question
Here is my problem.  My 41 year old single son purchased a new home for approximately $145,000 in 10 –2005 after putting down $1,500.  The recent appraisal came in at $200,000.00; this is in Arizona. He has had a drinking problem all his life. He lost his job 12-08-2005, and then got his 2nd extreme DUI 1-8-2006.  He signed title to the home to my wife and I for a consideration of $10.00.  We made the mortgage payment for Jan and will continue the payments.  This will not be a burden, especially if we can rent the home, which we intend to do.  The payment, without tax and insurance is approximately $800.00, we can rent it for that. The loan is still in his name until his court case is settled. I doubt my son will get the house back.  I am 60 years old, retired US Army and employed full-time. First I was wondering if I can get income tax benefit for the interest on the mortgage payment while the loan is in his name.  We intend to sell the home after two years. (We already own a home).  Am I on the right track and can you suggest anything?  Thanks

Answer
This property now becomes an investment for you and your wife. It is not treated like your house (deducting interest on the loan off your income tax).

Instead you must depreciate it.

A single-family dwelling investment is usually depreciated over 20 years. Sometimes the IRS may argue it should have been for more. However, I have experienced that 20 is mostly acceptable.

Example: If the appraisal (you should get a written one by a professional who is recognized for his expertise) is at $200,000, a "straight-line" depreciation takes about 20% off for land, depending on what the county assessor puts it at. The remaining 80% ($160,000) is taken off your income tax over 20 years ($8,000) per year.

The rent you receive is considered income on which you are taxed based on your tax bracket. The repairs you do for the property is also deductable. Keep good paper records.

So you can see you are now in a different tax world. There are a number of different ways to handle this. But you definitely must consult with your favorite CPA or tax consultant to make sure you are doing it right. You are in business. Yes, owning investment property should be treated as if you have a business.

If you sell the property within two years, depending upon the schedule of depreciation you choose (there are three of them), you may be subject to a recapture tax situation. So when you talk too your tax expert, discuss which schedule is the best for you. You definitely are going to be taxed upon the capital gain you get from selling the property. That's why you have depreciation to help alleviate your tax obligations. If the property sells for less than for what you received the property then there will be no tax gain.

Or when you sell the property, instead of outright selling and getting a taxable gain tax, you can exchange it in a tax-deferred (IRC 1031) transaction. You must exchange into a more expensive property to not pay any tax . . . for now. There's lots more to know. A good tax expert should be able to clue you in.

Then there is how you should be treating tenants, etc. But that is a different question. As I said, you are in business.

I do wish you well.

Dick Dennis  dixiedee13@aol.com