Suppose you are someone who lives near a college town or resort area and have extra rooms to spare in your home. You think to yourself, why not rent out one of the rooms since you aren’t using the space and make some extra money? Well, you could. But, since you are receiving rental income now, taxing authorities also want their share.
This extra income you receive must be reported to the IRS and state taxing authorities. However, there are deductions you can take against this income to reduce your tax liability associated with this extra income.
Similar to vacation rental property provisions, you can deduct certain expenses related to the room being rented. There are direct expenses that you can fully deduct and then there are indirect expenses for which you can only deduct the portion related to the room being rented. Deductible direct expenses are those that apply only to the room being rented. Some examples are furniture, repairs, painting, etc.
Other indirect expenses that must be allocated between the house and the room being rented are mortgage interest, repairs on the entire home, utilities, housecleaning, security systems, etc. In addition, you may also deduct depreciation on the part of the home you rent. Dividing the expenses between the room and the personal portion of your house must be reasonable. A typical method that has been approved by the IRS is to divide the home between personal and business based on square footage, but there are other methods. Also, you must keep good records of your deductible expenses as support in case the IRS wants to challenge it.
Rental activities are considered passive activities for federal tax purposes. Why that matters is because if you have rental losses in a particular year, you can only offset that loss with other passive income. Wage income, self-employment income or investment income cannot be offset with rental losses. This is something to keep in mind when thinking about tax planning for the year.
Lastly, many municipalities have registration and/or reporting requirements for rental properties so be sure that you are in compliance with local law authorities.
If this sounds like your situation, contact The Tax Warriors® at Drucker & Scaccetti and let us help you take advantage of the planning opportunities available to minimize your tax liability.