Many local students, graduates and young professionals seek to live within the city bounds of Rochester. With the high price of properties, some homebuyers have turned to an increasingly popular option: a two-family home, or a duplex. While duplexes carry with them numerous responsibilities, they offer distinct advantages to those looking to land their desired location.
Cost subsidizing is the first benefit that comes to mind. Normally, homebuyers view rental income as covering a portion of the mortgage payment. A more thorough calculation encompasses all of the monthly expenses, including mortgage, taxes, insurance, utilities, and upkeep. For a $280,000 duplex with a $30,000 down payment and a 4.25% interest rate on a thirty-year mortgage, the total monthly expenses reach about $2,590 per month. For a $250,000 duplex, the total expenses reach about $2,315 per month.
A $250,000 single-family home costs about $2,420 per month; and a $200,000 single-family home costs about $1,965 per month. The monthly costs to rent vary. A studio or one-bedroom apartment could cost as low as $800 to $900 per month, and a three-bedroom apartment could cost up to $1,600 to $1,700 per month. A fair medium to rent in the area is about $1,300 per month.
When the landlord generates $1,300 per month in rent, the monthly costs of owning a $280,000 duplex come in at about half of the cost of a similarly priced single-family home, and just below the cost of renting. The monthly costs of owning a $250,000 duplex come in at well below half of the costs of a similarly priced single-family home, and up to $285 per month less than renting. Of course, the actual numbers will differ for each property.
Because the main attraction is the income stream, it must be protected. Two strategies are particularly helpful. One is to make the lease for the total year’s rent rather than to divide it up into twelve different monthly fees. A landlord can specify that the payment will be divided into twelve monthly payments solely for the convenience of the tenant. If the tenant breaks the lease, the amount owed to the landlord is the full year’s rent. Second, a landlord could declare that specific promises or duties of the tenant are by the way of additional rent. If those duties are not performed, the tenant has failed to pay the rent and has broken the lease. These strategies get a potential landlord thinking about how to address common issues with different, unique tenants. They are by no means exhaustive.
Another distinct advantage of duplex ownership is the deductions. When occupying a duplex, a landlord is entitled to numerous deductions related to the rental portion of the duplex, one of which is for repairs. These deductions are available even where there is no tenant. All that is required is that the property be held out for rent.
In addition to repairs solely for the rented unit, landlords make repairs that impact both the residential and rental property – i.e., painting the outside of the home. For such repairs, half of the costs are deductible. Early attention to deterioration helps characterize maintenance as tax deductible repairs rather than improvements that materially add to the value of the property or substantially prolong its life, which are non-deductible, but depreciable, expenses. Other deductible expenses include advertising, utilities, fire and liability insurance, taxes, maintenance, and the rental portion of the interest paid on the mortgage.
A third advantage, and perhaps the least known to new homebuyers, is that the owner can depreciate the rental portion of the house. The income from a tenant in a landlord-occupied duplex is well protected, because the landlord can depreciate the value of the rental portion of the home over 27.5 years, and that depreciation is deductible from the rental income. Thus, the landlord is able to deduct both the yearly expenses and the depreciation from the income.
On a $250,000 duplex, the income should almost fully be covered by expenses and depreciation. The income would be around $15,600, with depreciation around $4,550. The expenses would reach around $10,000, including advertising costs, cleaning, maintenance, repairs, property taxes, mortgage interest payments, utilities paid, landscaping, and garbage. Most of the income would go untaxed.
The depreciation will decrease the landlord’s basis in the rental portion of home, eventually down to zero after 27.5 years. But, the landlord does not have a choice to enjoy the depreciation up front, or to maintain his basis. Rather, that value will be depreciated automatically when the landlord sells the home. If the landlord later recovers the amount of the home that was depreciated, that amount will be taxed at a higher rate. After the depreciated value is recovered, the rest of the gain is split between the rental portion and the resident portion. The resident portion would be untaxed up to a certain value, while the rental portion would be taxed at the capital gains rate.
Despite the advantages of being the landlord of an owner-occupied duplex, a multitude of issues may arise. While an oversized lease agreement may scare potential tenants, there are a few points that any landlord should at least consider. Some of those include: (1) method of payment; (2) treatment of late/bounced payments; (3) treatment of keys and locks; (4) pet policy; (5) storage; (6) parking; (7) responsibility and process for repairs; (8) security deposit; (9) right to sublease; (10) snow removal; (11) payment of heating and utilities; (12) cost of living adjustments; and (13) right to dispose of abandoned property.
Not everyone is cut out for the responsibility that landlord life entails. However, the benefits of purchasing a duplex may allow some homebuyers to live in a neighborhood they otherwise could not afford, and serve as an income stream down the road.
Tyler Ellis is an Associate at Boylan Code LLP, concentrating his practice on general corporate and tax matters. For more information, please contact Tyler at (585) 232-5300 or tellis@boylancode.com.
