We're feeling squished in our greater Boston 2BR condo, and this year
we have had to begin renting an outside office to accommodate our
little one's bedroom.  We're not thrilled with this arrangement. We're
interested in getting a comparison of the tax and financial
implications (home office deduction, mortgage interest write-offs,
rental deductions, etc.) for the following options. Eventually we plan
to buy a 3BR house with home office and rent out our condo, but here
are our options for the next two to three years.

1) Rent our condo out, and rent for ourselves a 3BR house with home
office inside. (Trade water view for more space).
2) Status quo: stay in our condo and keep renting an office outside.
3) Invest in improving our condo such that we can squeeze a home
office into our bedroom and have lots of storage space in other rooms.

Details:
- Our 2BR condo is currently worth $350,000. Very rentable. Very sellable.
- A smallish 3BR house would cost upwards of $450,000 in our area.
- We're currently renting an office at $600/mo.
- We think we could get $2000/mo for our condo.
- We would pay up to $2000/mo for a 3BR rental townhouse.
- We pay $1050 mortgage, $375 condo fee...incl. heat, $300 RE tax, $50 electric
- It would cost 10-20K to change our condo to include a home office.
- Our joint income is approximately 115K per year, both self-employed.
- Our condo mortgage was secured (via refinance) 2 years ago at 6.5%.
- We're in Massachusetts, where housing prices seem to have peaked.

Thank you.

Looks to me like renting the 3BR TH while renting out your condo is a
straight up pass through that won't cost you an extra penny except
landlord related costs and headaches. You keep your property and
deductions, you'll get to write off repairs and what-not (consult a
tax attorney to make sure; also, ask if you should incorporate), and
you'll be in a bigger place. Nice.

Are schools an issue at the "new" place?

Thanks for the comment!  I guess I don't understand if I can write off
the mortgage interest in the same way if I'm a landlord rather than an
occupant of my primary property, and how badly the home office
deduction loss would affect me.  Nope, schools are not an issue as
we'd be moving within the same town.

As I said, you should talk to a tax attorney to make sure, but you'll
probably come out with more deductions rather than fewer. You don't
lose the home office deduction if you still maintain a home office;
you still deduct mortgage interest; and you get to deduct repairs,
mileage, and other costs of landlording.

How you deduct them is what you'll need to learn and a tax attorney
(NOT some dip who took a two week course at a storefront tax preparer)
will be able to recommend the ideal way to structure the situation.
State tax, incorporation, AMT, permits, and goodness knows what other
variables need to be considered.