When you rent out part of your personal property, it’s not just that you get added income (that you have to report), but now part of your property is open to expenses and deductions.
To begin with, you must divide expenses between personal and rental use. You can deduct the rental portion of the expenses on Schedule E of your 1040 and the personal expenses (such as mortgage interest and property taxes) on the Schedule A of your 1040. It may go without saying, but if you have any expenses that belong strictly to the rental portion of the building, then these do not need to be divided.
So, let’s give a for instance, let’s say you have a two-story home and you decide to convert the top floor into an apartment (available for rent). In this scenario, you must divide expenses between your personal property and rental; this includes mortgage interest and property taxes between the part of the home you live in and the part that’s rented out. The best way to do this is based on the square footage of the total house and the part you rent out.
In addition, you need to divide homeowners insurance and utilities between the rental and non-rental portion. Utilities includes phone lines, wi-fi, water, sewage and waste, and electricity.
Now we get to the rub. The non-rental portion of the insurance and utilities is not deductible on your tax return, but the rental portion is deductible as a rental expense on Schedule E of your 1040.
Note that if you have separate internet for the rental portion (and you charge the tenant rent for it) or if you have a phone line running only to the rental, then these type of expenses are fully deductible as a rental expenses since it is not being used by the rest of the home.
All this said, this example shows a clear divide between your personal property and rental. So what do you do when you rent out a room in your house? How do you account for shared space like a bathroom or kitchen? Well… it’s easier than it sounds. You have two options.
- Option 1: Let’s say you measure the room (and closet) the person is renting out and it’s 475 sq. feet. Your total square footage for your house is 1,750. So you don’t simply deduct that amount, you deduct the percentage. In this case, that room makes up 27.14% of your home. So you can deduct 27.14% of your total home.
- Option 2: Rather than deduct the exact square footage, you can deduct a percentage of your house. So if you deduce (and can reasonably show) that the person renting your house accounts for 30% of the total home, you can choose that option as well.
Now, if you want to complicate things further, let’s say you want to deduct a portion of your home as a dedicated office. Similar rules apply because essentially you’re applying a business expense to a larger percentage of your house. It can make your accounting a bit complicated.
If you have any questions about what is deductible as part of your rental and what expenses need to be divided then it is best to consult a tax professional.