Renting Part of a Home & Claiming a Legal Tax Deduction
In addition to commercial landlords, ordinary homeowners sometimes try to rent out rooms or sections of their home to generate another income source. Rent from a tenant is subject to taxes, but you also may be able to claim deductions if you rent out part of your home. Rules on deductions apply in the same way to ordinary homeowners as to commercial landlords. Renting to a tenant is considered a business activity, so the related expenses are subject to deductions. The type of deduction will depend on whether a certain expense affects the entire home or only the rented area.
If an expense affects only the area controlled by the tenant, you can deduct the expense in its entirety. In some cases, you may need to spread the deduction over multiple years as depreciation. Any additional costs that are solely related to the tenant’s use of the property, such as a second insurance policy, can be fully deducted as well. The calculation is more complicated if the expense benefits your entire home.
Calculating Deductions for Benefits to the Entire Home
Some types of expenses benefit both the area controlled by the tenant and the area controlled by the homeowner. These may include repairs or improvements to the structure or exterior of the home, a homeowners’ insurance policy, mortgage interest, security costs, and utilities costs. Depending on the type of home and where you live, other expenses may include trash removal, landscaping, housecleaning, and snow removal. If you live in a condominium, you probably need to pay fees to the condominium association to contribute to the maintenance of common areas.
Rental property owners generally cannot deduct the cost of improvements. The cost of improvements can be recovered through depreciation.
To calculate your deduction, you will need to divide the part of the home controlled by the tenant from the part of the home controlled by the homeowner. In other words, you must view the home as though it were two separate properties, even though it is a single structure. Many people calculate the deduction according to the number of rooms controlled by the tenant, compared to the total number of rooms in their home. Or they may compare the amount of square footage controlled by the tenant to the total amount of square footage in their home. For some expenses, such as utilities, it might make more sense to calculate the deduction by comparing the number of tenants to the number of total people in the home. The most advantageous type of calculation is often the number of rooms.
Getting the Pass-Through Deduction
Under the Tax Cuts and Jobs Act, which went into effect in 2018, the owners of a pass-through business are entitled to a deduction for up to 20 percent of the net profits of their business. The deduction may cover a smaller percentage if their overall taxable income exceeds a certain threshold or if they operate a certain type of business. A pass-through business can be a sole proprietorship, a partnership, an LLC, an LLP, an S corporation, or essentially any other type of business that is not a C corporation. If you are making a profit from renting part of your home, even if you do not see yourself as a “business owner” and do not have long-term tenants, you may qualify for the pass-through deduction.