Tax Tips Blog

Tammy writes: I’ve been renting out the lower section of my house. It has a separate entrance from the rest of the house and also its own sink. My renter has full kitchen privileges. I have been collecting 1/2 of my utility costs (TV/Internet, water, electricity), in a separate check, from the renter as well. I have been treating her monthly rent as taxable income and the utility money as a reimbursement and not reporting it. I was wondering if I can depreciate the portion of the house that she lives in? I was also wondering if I could deduct my expenses (installing window treatments, adding a closet, etc.) that I have incurred in order to rent this section of my house? Thank you.

My reply: I hate to be the bearer of bad news, but it doesn’t sound to me like you’ve been reporting this business correctly.  Although it may seem easy to prepare your own tax return, it would be in your best interest if you hired a qualified tax professional to assist you since you have this rental property.

You should be reporting the entire amount of money that you receive from your renter as rental income on Schedule E of Form 1040. Then, you are allowed to deduct her portion of the utilities as an expense on Schedule E.

Yes, you can depreciate the portion of the house that she lives in, but not the land. You need to determine the value of the house, on the date that you converted it to business property, and separate out the land value from the building value and then depreciate the building value.

You are also allowed to deduct any expenses that you incur, such as the utilities mentioned above, advertising, insurance and repairs and maintenance, which directly relate to the rental income you are receiving.

As for the items you mentioned - installing window treatments and adding a closet - these are considered capital improvements, because they have a useful life of more than one year; thus they must be depreciated.

Best wishes, Gina

www.GLGcpa.com

Paul owns a condominium in Galveston, Texas and would like to use this unit himself for 30 days per year and try to rent it out the rest of the year. He wants to make sure that this condominium unit does not get classified as his personal residence come tax time. Paul thought if he hired a rental company, then it would “prove” that he was holding it as a rental property and not a personal residence so he would be able to deduct his associated expenses. Sadly, that’s not exactly how the tax rules work. He was researching management rental companies that would let him use the property for 30 days each year. One of the management companies offered to manage his property’s rental for him based on a guaranteed annual rent of $20,000 without regard to how often the property is used. A different management company offered to manage his property’s rental for him in exchange for 50% of the actual rents the company collects for him. If Paul wants to guarantee himself that he will not be subject to the personal residence rules, then he should consider the guaranteed rent arrangement. This arrangement has 335 rental days (365 days per year less 30 days of personal use), so Paul’s use of the condo is less than 10% of the rental days. Paul would be able to report his net rental income or loss, subject to the passive loss rules, from the condo. If Paul instead chose the other rental management company there is no guarantee that the condo will be rented enough during the year to avoid it being classified as a second home or vacation home.

Ron and Patricia’s live on Lake Palestine, in Bullard, Texas. They are planning a vacation next summer and wanted to know what the tax ramifications would be if they rented their primary home while they go on vacation. They are hoping to rent it for $2,000 per week. Because the home is their personal residence, if they rent it for fewer than 15 days during the year, the rental income is not taxable. You read it correctly, if they rent their home for 14 days and collect $4,000 - they will not be taxed on that $4,000 of income. Of course, any rental expenses they incur will not be deductible. However, they would still be allowed to fully deduct their qualified residential interest expense and real estate taxes on Schedule A (subject to the overall limitation on itemized deductions). However, if they rent their primary residence for more than 14 days, the calculation become much more complex. There are a set of ordering rules that must be followed to determine which expenses can be deducted and to what extent. It is best to consult with your tax advisor in this situation.