Previously, we reviewed rental income taxation. However, it is also common for property owners to just rent out part of their property.
In this week’s post, I explain some of the tax implications of renting out a room.
Basic formula
As discussed previously, the basic formula for calculating rental income is: rents – expenses = income (loss). The expenses include a variety of things, such as: advertising, cleaning and maintenance, insurance, mortgage interest, taxes, utilities, and depreciation. The formula for calculating income from renting out a room is the same. However, some expenses have to be split between the rental use of the property and the personal use of the property.
Certain expenses must be split
When renting out part of a property, expenses attributable to the rental use of the property are reported on Schedule E. Certain expenses attributable to the personal use of the property can be deducted as itemized deductions on Schedule A (if the taxpayer itemizes). Note that many of the expenses deductible on Schedule E are NOT also itemized deductions. For example, cleaning supplies used to clean the rental portion of the house are deductible, but cleaning supplies for personal use are never deductible. Two expenses that are both deductible as rental expenses and itemized deductions are taxes and mortgage interest.
Expenses that only belong to the rental portion of property (advertising, for example), do not need to be divided - they are fully attributable to the rental use of the property.
How are expenses split?
Expenses can be split in different ways. The IRS guidance states that a taxpayer can use any “reasonable method” to divide expenses. An example is given that it may be reasonable to divide select expenses, such as water, per person. However, dividing expenses by number of rooms or square feet are the most common. Most examples and guidance I have seen rely on square feet - the portion of the rented space to the total size of the property.
For example, Reid rents out a 200 square foot room in his 2,000 square foot house. 10% (200/ 2,000) of his mortgage interest will be deducted as a rental expense on Schedule E. The remaining 90% will be an itemized deduction (if he itemizes).
Like other expenses, depreciation is also split. For example, if 25% of a house is being rented, depreciation can be taken on the value of 25% of the house.
If you are using tax preparation software to prepare a tax return with a room rental, be careful to make sure that all expenses are being properly split. I have seen and heard that at least a couple of popular tax preparation programs make it difficult to properly split these expenses - casually going through the questions will result in overstating rental expenses and understating income.
Splitting expenses based on when the rental portion was placed in service
Expenses will be further divided by the time a property was placed in service, or available to be used as a rental. For example, a property is split between 30% rental use and 70% personal use. Further, the property became available for rent at the beginning of October (25% of the year). Only 7.5% of expenses for the year will be attributable to the rental (30% rental use * 25% time in service).
Example of splitting expenses
Alan rents out a spare bedroom that is 150 square feet. His house is 1,200 square feet. He decides to divide all expenses based on square footage. 12.5% of the space is rental use (150 / 1,200). The spare bedroom is rented for the entire year. He has a variety of expenses to allocate:
Advertising ($100) – applies to the rental only
Interest ($1,000) – split between rental and itemized deduction
Utilities ($800) – split between rental and not deductible
Taxes ($3,000) – split between rental and itemized deduction
Depreciation ($10,000) – split between rental and not deductible
If you have any comments, questions, or ideas for future posts, please let me know
I hope you found this post helpful and educational. If you have any comments, questions, or ideas for future posts, please let me know. You can reach me directly via email at crawford@ulmerfinancial.com.
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