Tax Issues When Renting Out a Room in Your House

Lots of people are trying to earn a few extra bucks by renting out a room in their home. As far as taxes go, this comes with bad news and good news.

The bad news is that the rent you receive is taxable income that you must report to the IRS.

The good news is that your taxable rental income can be wholly or partly offset by the tax deductions you'll be entitled to.

Deductible Expenses

If you rent out a room in your home, the tax rules apply to you in the same way as they do for landlords who rent out entire properties. This means you get to deduct the expenses arising from your rental activity. There is one big difference however: You must divide certain expenses between the part of the property you rent out and the part you live in, just as though you actually had two separate pieces of property.

You can fully deduct (or, where applicable, depreciate) any expenses just for the room you rent—for example, repairing a window in the room, installing carpet or drapes, painting the room, or providing your tenant with furniture (such as a bed). In addition, if you pay extra homeowners' insurance premiums because you're renting out a room, the full cost is a deductible operating expense. If you install a second phone line just for your tenant's use, the full cost is deductible as a rental expense. However, you cannot deduct any part of the cost of the first phone line even if your tenant has unlimited use of it.

Expenses for your entire home must be divided between the part you rent and the part you live in. This includes your payments for:

• mortgage interest
• repairs for your entire home—for example, repairing the roof or furnace, or painting the entire home
• improvements for your entire home—for example, replacing the roof
• homeowners' insurance
• utilities such as electricity, gas, and heating oil
• housecleaning or gardening services for your whole home
• trash removal
• snow removal costs
• security system costs, and
• condominium association fees.

You can also deduct depreciation on the part of your home you rent.

You can use any reasonable method for dividing these expenses. It may be reasonable to divide the cost of some items (for example, water) based on the number of people using them. However, the two most common methods for dividing an expense are either based on the number of rooms in your home or based on the square footage of your home.

Example 1: Jane rents a room in her house to a college student. The room is 10 × 20 feet, or 200 square feet. Her entire house has 1,200 square feet of floor space. Thus, one-sixth, or 16.67% of her home is rented out. She can deduct as a rental expense one-sixth of any expense that must be divided between rental use and personal use.

Example 2: Instead of using the square footage of her house, Jane figures that her home has five rooms of about equal size, and she is renting out one of them. She determines that one-fifth, or 20%, of her home is being rented. She deducts 20% of her expenses that must be divided between rental and personal use.

As the examples show, you can often get a larger deduction by using the room method instead of the square footage of your home.

Be sure to keep good records of your deductible expenses when you rent out a room.

20% Pass-Through Deduction

You may also qualify for the new pass-through tax deduction established by the Tax Cuts and Jobs Act. Starting in 2018 (and scheduled to last through 2025) pass-through business owners—that is, owners of any business other than a regular C corporation—may deduct up to 20% of their net business income from their income taxes (less if taxable income exceeds certain levels). Renting a room to short-term guests can qualify as a business, especially if you earn a profit each year. Thus, if you own and operate your room rental activity as an individual (or tenant in common) or through an LLC or partnership, you may qualify for this valuable deduction.

For more on this topic, see Tax Guide for Short-Term Rentals: Airbnb, HomeAway, VRBO and More, by Stephen Fishman.