Do I have to pay income tax on 60-day leaseback and if so, can I write off home improvements during those 60 days?

Forum|Forum|5 years ago
September 16, 2020
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My husband and I recently purchased a second home and will continue to maintain our primary residence a few hours away. We only put 10% down on the house and, accordingly, our mortgage stipulates the home cannot be a rental/investment property.
Under the sales contract, we have agreed to let the sellers do a leaseback while they close on their new home (paying us $100/day) and our mortgage company has agreed, with the restriction that it can only be for up to 60 days. I have two questions:
1) Are we required to pay federal income tax on the money we collect during the leaseback period (up to $6k)? Note that the monthly income will exceed our mortgage payment by $900/mo, so it technically is income vs. just covering our mortgage payment.
2) If we are required to pay taxes on that money, are we at least allowed to write off any home improvements while the sellers are there during the leaseback period? For example, the sellers have agreed to let us break ground on a pool while they are staying there, as well as installing a new garage door and painting the exterior of the home.

Opus 17

Usually, such agreements are for the mortgage payment and the best advice is to ignore it. You would have no profit and could even show a loss on paper but it would cause a headache when you go to sell.

Your income will be substantially more than the mortgage payment, though. On schedule E for rental income, you can deduct other rental expenses including utilities, lawn care and property maintenance (if you pay those expenses) and property tax for the rental days. You’ll probably still end up with a profit, and it might be best to declare it and pay taxes.

The fact that the mortgage agreement does not allow rentals has nothing to do with taxes. The IRS doesn’t care if you violate the mortgage, they want your taxes if you owe them.

You never deduct the cost of improvements as a rental expense. Improvements are depreciated over their useful life, which is probably 27.5 years for the pool, and you can only start taking depreciation when the improvement is placed in service (installed, has all permits, ready to use).

Painting is maintenance, not an improvement, but as you are really painting for your own benefit, you would likely lose the deduction and pay penalties and interest if you were audited.