Is Renting a Room an Investment for Income Taxes & the IRS?
Renting that unused room in your basement can be a good way to help meeting your mortgage payment each month. If you’re not careful, it can also be a good way to run afoul of the taxman. The Internal Revenue Service treats renting out a portion of your primary residence the same as renting out a completely independent property. Because of this, you’ll need to report rents as investment income.
If you act as a landlord, the IRS considers any revenue your activities generate as taxable income, and renting out a portion of your primary residence is treated the same way. You’ll need to treat the portion of your home that’s used by renters as an individual rental property, separate from your residence. While you’ll need to perform some extra paperwork in this situation, it allows you to deduct expenses from your rental activity, which reduces the taxable income the rented room generates.
Apportioning Your Home
While the rented room is a separate rental entity in the eyes of the IRS, it shares many expenses with your personal home, such as mortgage payments and utility bills. The IRS allows you to divide expenses between the rental property and the part used for your residence using any reasonable method you choose. Many landlords use the proportion of total bedrooms in the home that are rented or the proportion of square feet rented out to split expenses. For example, if you own a three-bedroom home and rent one room out, you can claim 33 percent of shared expenses as business expenses.
Direct Expenses and Loss Carryovers
In addition to shared expenses, you can also deduct any direct expenses associated with renting the room from rental income. These expenses include advertising the room, the cost of credit checks you incur when screening tenants and charges related to cleaning or changing locks between tenants. If you’re not renting the room for a profit -- merely trying to cover mortgage and upkeep costs -- you can claim these expenses, but your expenses can’t be more than rent revenue, and you can’t carry losses forward into future tax years.
Steve and Liz have an extra bedroom in their four-bedroom home they rent to Mark starting Jan. 1. They determine the rental room is one quarter of their shared expenses using the number of bedrooms as the basis for this determination. Because of this, each month they can deduct $500 of their $2,000 mortgage payment and $25 from utilities that average $100 each month. Mark’s rent is $700 each month, and after shared expenses, they receive $175 in income from the rental activity each month, or $2,100 in rental income each year. Before Mark moved in, they spent $100 listing the room in the classified ads and $50 getting the carpet cleaned. After deducting these expenses, they must report $1,950 in rental income. This figure is much smaller than if they merely claimed rents without deducting expenses, which would have yielded $8,400 in income through the year.
Wilhelm Schnotz has worked as a freelance writer since 1998, covering arts and entertainment, culture and financial stories for a variety of consumer publications. His work has appeared in dozens of print titles, including "TV Guide" and "The Dallas Observer." Schnotz holds a Bachelor of Arts in journalism from Colorado State University.