USA Mother-In-Law Apt and Taxes

[Chell]

Hello Everyone:

I was hoping someone might offer some insight into how a mother-in-law apartment would be handled on my income taxes. Here is the basic situation:

1. I purchased a house late in 2012 and started work on converting the basement into a mother-in-law apartment while living on the property. My plan is to live in the basement and rent the upstairs.
2. I have spent around $20,000 to $30,000 on this project. The majority was spent on the basement apartment, some was spent on things that separate one space from the other, some was spent on common areas, and the rest on repairs/improvements to upstairs unit. Only $3,500 was spent on contractors; the balance consists of either materials or permit fees.
3. The upstairs will be available for rent starting in January 2014.
4. I have been unemployed since the middle of 2013.

Given this situation, what would my 2013 taxes look like? Since the rental will not occur until 2014, it is my understanding that I would NOT file schedule E for 2013 taxes. On the other hand, it seems that I could deduct all of the property taxes and the mortgage interest I paid 2013 as though the property is simply a primary residence. Correct?

In 2014, I think I would file schedule E since I have a portion of my property used a rental property. The first question I have at this point concerns the basis of the house.

It seems like the basis of the house increased in 2013 due to the construction. In 2013 it also seems that this would have no impact on my taxes since it was at that time a primary residence and I of course did not sell the property during that year.

In 2014, it seems like I need to figure out how divide the basis of the house between the rental portion and the part I personally live in. Should I pick an arbitrary number like 50/50 or do something else?

If I do something else, should I put the large majority of the construction costs into the basis of the rental since that money was spent so that I would have something to rent. Or should it be put into the non-rental portion since the money was spent for the area in which I will actually live? What should I do about the money spent on the common areas?

Finally, it seems to me that I need to divide any expenses that occur in 2014 into one of four categories:

1. Expenses related to renting or repairing the rental portion
2. Expenses related to repairing the non-rental portion.
3. Expenses that benefit both the rental portion and the non-rental portion. Divide by some formula? For example, new washing machine that is shared by both me and the tenant. Rental portion claimed on schedule E and non-rental portion ignored, correct?
4. Improvements to the rental portion. Say a new fancy bathtub. Goes to basis of rental portion?
5. Improvements to the non-rental portion. Goes to basis of non-rental portion?
6. Improvements to both the non-rental and the rental portion. For example, a new fence that benefits both portions. Or maybe a detached garage with 1/3 of the space dedicated to the rental portion. Part goes to the rental basis and part to the non-rental basis? How do I divide things?

Any insight would be greatly appreciated.

Sincerely;
Michelle

 

[kirby]

Given this situation, what would my 2013 taxes look like? Since the rental will not occur until 2014, it is my understanding that I would NOT file schedule E for 2013 taxes. On the other hand, it seems that I could deduct all of the property taxes and the mortgage interest I paid 2013 as though the property is simply a primary residence. Correct?

Yes, you are correct - for 2013 you do not file a Schedule E.
You just own a house and, of course, can deduct the prop tax and mortgage interest
For any start-up costs you have before your rental starts, capitalize them and amortize them.

 

[kirby]

In 2014, I think I would file schedule E since I have a portion of my property used a rental property. The first question I have at this point concerns the basis of the house.

It seems like the basis of the house increased in 2013 due to the construction. In 2013 it also seems that this would have no impact on my taxes since it was at that time a primary residence and I of course did not sell the property during that year.

Yes, in 2014 you will file a schedule E.
Yes, the tax basis of your house increased and be sure to keep copies of all the construction cost invoices and payments NOW so you will have that info on hand if you ever sell the house.
And, yes, the increase in tax basis will not affect your income tax. But if you filed all the proper construction permits expect the state property tax guys to add that to the cost and increase your property tax bill at some point. Also, you may want to review if you need more insurance coverage on the house.