Many people are looking to earn extra money by renting out a room in their homes. When it comes to taxes, this is both good news and bad news.
The good news is that your rental income that is taxable can be partially or totally offset by the tax deductions you are entitled to. The not-so-good news is that the rent you receive is considered taxable income that you must report to the IRS.
Deductible Expenses
If you rent out a room, the tax rules apply to you in the same way it applies to your landlord, who rents out his/her entire property. This means that you can deduct the expenses of your rental business. However, there is a big difference: you have to split some expenses between the part of the property you rent and the part where you live as if you own two separate properties.
You can deduct (or, if applicable, write off) any expenses just for the room you are renting, such as repairing a window in the room, installing rugs or curtains, painting the room, or your tenant's furnishings (such as a bed). Plus, if you pay additional insurance premiums for landlords to rent a room, the total cost is a deductible operating expense. If you install a second telephone line for the exclusive use of your tenant, the total cost will be deductible as a rental expense. But, you cannot deduct any part of the cost of the first telephone line, even if the tenant has unlimited use of it.
The cost of your entire home should be split between the part you rent out and the part you live in. This includes your payments to:
Cleaning or gardening services for the whole house
Condominium association fees.
Homeowners Insurance
Improvements to the whole house, e.g., roof replacement
Mortgage interest
Repairs of the whole house, for example, by fixing the oven or the roof or painting the whole house
Snow removal costs
The costs of the security system
Utilities such as electricity, gas, and fuel oil
Waste treatment
You can also subtract depreciation on the part of your home that you rent out.
You can use any reasonable technique to allocate these expenses. It may be reasonable to divide the cost of some items (e.g., electricity) by the number of people using them. However, the two most common ways to divide an expense are based on the number of rooms in your home or the square footage of your home.
Examples
1) John rents a room in his house to a student. The room measures 10 feet by 20 feet or 200 square feet. The entire home is 1,200 square feet. Therefore, a sixth is rented, or 16.67% of your home. One-sixth of all expenses can be deducted as rental expenses to be split between personal and rental use.
2) Instead of using the square footage of his house, John calculates that his house has five rooms of approximately the same size, and he rents one of them. He decides that a fifth, or 20%, of his house, should be rented. He deducts 20% of his expenses to be split between rent and personal use.
As the examples show, you can often get a larger deduction by using the room method rather than the square meter at home.
Make sure you keep a good record of your deductible expenses when renting a room.
20% Pass-Through Deduction
Also, you may be eligible for the new tax deduction permit established by the Tax Cuts and Jobs Act. From 2018 (and until 2025), pass-through business owners, i.e., owners of any business other than a regular C corporation, can deduct up to 20% of the net income of the business tax returns (unless taxable income exceeds certain levels). On a short-term basis, renting a room to short-term guests can be considered a good deal, especially if you make money every year. Therefore, you may qualify for this valuable deduction if you own and operate a room rental business as an individual (or tenant) or through an LLC or partnership.
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Pat Raskob