This is a Guest Post by Linda Nellett, another homeowner who rents out a room in her house.
Previously, she has written a guest post about her experience as a women renting out rooms in her house. This time she’ll share her insights on how renting rooms has impacted her taxes. Disclaimer: Neither I, nor Linda are accountants or tax specialists, so this article will not provide authoritative tax guidance. Linda was kind enough to share her own experiences. Consult a tax advisor to discuss your own particular situation and what will work best for you.
I’ve been renting two spare bedrooms in my house since October 2009, which means I’ve gone through two tax years. In November 2009 I met with my accountant to discuss how renting out rooms would affect my filing for the 2009 tax year. I brought the following information with me to the meeting: the original real estate listing of the house with room dimensions (so we could calculate the percentage of the house being rented); copies of the rental agreements; copies of my property taxes; and receipts for repairs and updates made to the house. My accountant and I discussed the fact that I would have more forms to complete for 2009 than in previous years, and he assured me that it would very likely benefit my tax situation to be renting rooms.
When the tax planning forms arrived in January 2010(tax planning forms are resources to assist in organizing your deductible expenses so that at the end of the year you’re not left scrambling to find everything you can deduct for that year), I tabulated receipts and statements, and filled out the new sections of my tax planner. Here are my numbers for 2009 with only three months of rental income and expenses:
Notice that my Expenses exceeded by Income in 2009. My accountant added Schedule E (Form 1040) Supplemental Income and Loss to my tax filing and documented these figures and the resulting $82($2032-$1950) loss. We also had to complete Form 8582, Passive Activity Loss Limitations, to document total losses did not exceed the amount allowed. The loss actually reduced my tax burden, which was a great result. When I look at my 2009 Form 1040 I can clearly see on Line 17 where the $82 loss is recorded, resulting in a lower adjusted gross income.
In speaking with another person at work who owns a two flat (a house with two totally separate living units), this is not an uncommon outcome. My colleague lives in one of the units and rents the other. Like me, the repairs and maintenance she makes to the building and property – things she would have to do anyway as a homeowner – are now business expenses. And my colleague pointed out with a smile that her expenses are always more than her income.
The loss of $82 really isn’t much and didn’t really have an impact on my Adjusted Gross Income for 2009. Let’s look at my numbers for 2010, where I’ve had a full year of rental income and expenses.
For 2010, I had a loss of just over $4,000. The $4,000 loss will again reduce my 2010 adjusted gross income. This is the figure used by the IRS to calculate the total tax for the year. A good rule of thumb to follow is the lower your adjusted gross income the lower your taxes.
I’ve noted a lot of figures here for things like cleaning and maintenance, repairs, and supplies. Some of these figures are tallied from paper receipts I’ve saved all year in my 2010 Income Taxes folder, while others are from monthly statements. What sorts of items are included in my documentation?
- Maintenance activities: tree-trimming, landscaping service and pest control (too many ants this year!).
- Insurance: the cost of my annual homeowner’s insurance.
- Repairs: updates/fixes to gutters and downspouts, spot tuck-pointing, fixing a faulty light fixture, and installing a new storm door.
- Supplies to maintain the property: light bulbs for common areas, water filters for the refrigerator, a new smoke detector, a new shade for one of the bedrooms, a replacement shower-head for the bathroom shared by the renters, and ice melting compound for the sidewalks.
- Basic utilities: water/sewer/trash, electricity, and natural gas.
- Other utilities I provide as part of the rental agreement: Internet service.
Again, these are expenses I would have had anyway as a homeowner. Yet now that I’m renting rooms in my house, they are considered rental property (business) expenses.
Other fees that could be noted as property expenses include:
- Advertising costs for listing the property with services such as roommates.com or another service to find renters.
- Cleaning service for common areas such as kitchen, living room, etc.
- Commissions paid to individuals or services to secure renters.
- Supplies that are used for cleaning or could be provided gratis under the rental agreement, such as paper towels and dishwasher detergent.
I personally haven’t incurred expenses for advertising, cleaning, and commissions in the past two tax years, but I know I could be more thorough about documenting the cost of supplies. If you’re considering renting out rooms in your house be sure to start a new file at the beginning of the tax year to keep paper copies of your receipts and documentation, or scan your receipts and save them in an electronic file with notes. This will make your filing process much easier the following year.
On Schedule E there are also lines to document mortgage interest and real estate taxes. My accountant didn’t list these expenses on Schedule E in 2009, and I assume he did this deliberately as it would have brought me no additional advantage. Instead those expenses were included in Schedule A with the rest of my typical itemized deductions.
Some people who are renting out rooms may be tempted to not claim the income on their taxes. Besides the legal and ethical issues involved with under-reporting income, I think my example shows that those people are really doing themselves a disfavor financially, as well.
It’s interesting to see in Linda’s particular situation, she has been able to lower her adjusted gross income by taking a loss on the rental income. This may change depending on how much her variable expenses are from one year to another.
Again, a reminder this post was written to provide insights on a particular situation. Please consult a tax advisor to discuss your own particular situation and what will work best for you.