Renting Out Part of Your Home

What are the tax issues when I rent out part of my home?

When most people think about ‘rental properties’, they picture buying a small house or condo and collecting rent from a tenant.  The tax issues with doing that are relatively straightforward: you just keep track of how much they paid you, and how much you spent on expenses related to the property, and the net amount is what you pay taxes on.

But what if you’re not renting out a different property?  What if you’re just renting part of the house you already live in?  How do you determine which expenses you can deduct?

First – find out if you even need to pay taxes

Before we talk about potential tax issues, there’s an important exception you should be aware of.  If you rent your own home for 14 days or less, you don’t need to pay a single penny in taxes.  It doesn’t matter how much they paid you or who the tenant was.  So if you turn your apartment into an Airbnb for a couple of weekends and make a killing, you don’t need to tell the IRS. 

If you have a longer-term tenant

Assuming the above exception doesn’t apply to you and you rent your property for more than 14 days, you’ll report your rental income on your tax return on Schedule E.  The income you receive from the tenant will be reported as revenue. Just like you would with a separate rental property, you can deduct rental expenses related to the maintenance and upkeep of the property.  It’s just a little more complicated.

There are two different types of rental expenses that you should be aware of.  Direct expenses are expenses you can assign specifically to the rental portion of your home.  So, if you’re renting out the basement of your house, and the toilet in the basement bathroom needs to be replaced, that would be a direct expense.  The entire amount would be reported as an expense on Schedule E.

Indirect expenses are a little more work to figure out.  Essentially, they’re expenses that aren’t specifically related to the rental portion of the property, but contain amounts that are rental-related. For example, if you have a mortgage, a portion of the interest paid can be assigned to the rental property. How do you split the bill?  The IRS says you can use “any reasonable method”.  In practice, this typically means either dividing by square footage or dividing by total number of rooms.  If your entire house is 2,000 square feet, and you’re renting out 500 square feet of space, you can deduct 25% of your mortgage interest for rental purposes.  You can also use this allocation to divide costs on things like real estate taxes, utilities paid for the whole house (assuming the rental portion doesn’t have its own meters), a new roof for the entire property, or landscaping costs.

One word of caution: if you’re deducting things for the rental you would otherwise deduct yourself, you can’t double-count anything. If you paid $20,000 in mortgage interest and half of it was related to the rental, you would use $10,000 on Schedule E (rental income) and $10,000 on Schedule A (itemized deductions). 

What if I move out?

If you find yourself in a situation where you wind up moving out of your primary residence during the year and turning it into a rental, you’re still entitled to all of the rental expense deductions as if it were a totally different property.  The only difference is that in the year you converted it into a rental property, you would divide the number of days it was rented at fair market value out of the entire year.  For example, if you moved out and tenants moved in on October 2, the property would have been rented for 90 days at the end of the year.  You can deduct 90/365, or 24.6%, of your mortgage interest for the year as a rental expense.  The following year, if it were rented the entire year, you would simply deduct the entire amount.

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