Roommate income and deductions?

[orlycpa]

We bought a house this year and rent out two of the three bedrooms. The entire home is shared except for our own bedroom and bathroom area, and of course each of their rooms and bathrooms. I'm a little confused about the shared living space versus rental income. Do we actually have to report the income we've received or is it considered sharing? I doubt it's the shared situation because we actually own the home... right?

And -- I know deductions will be split based on the percentage rented (is that including shared/common space?) and then also - what can we deduct? Mortgage payment? We aren't deducting interest we already know, it won't exceed our standard deduction. Utilities? items we furnish it with?

Thanks for any help! 

[Critter]

First you have to figure out if you have a formal rental (did you have them sign a rental agreement)  or just friends sharing expenses  ... start with your state's rules ... some have renters credits which your renters will want to claim and some states have regulations on what is a landlord and what they are required to do.   Once you know the rules you can play the game. 

[Hal_Al]

Q. Do we actually have to report the rental  income we've received or is it considered sharing? 

A. Simple answer: it's considered sharing.

If this is merely a cost sharing arrangement where the amount paid is below fair market rental, there would be no reportable income to you. If the “rent” amount is fair market value, or more, there is still some question as to whether you even have to report it, as it almost always comes out zero. Most people take the attitude that it is not income; it's just room mates sharing expenses and ignore it. Family, as opposed to unrelated roommates, makes that position stronger.

Here’s what you may be required to do:

Report the income (enter at Rents & Royalties/Income & expenses from Rental Properties); and then deduct the expenses on schedule E. If the room mate has full run of the house, and there's just the 2 of you, then half your expenses are deductible (mortgage interest, property taxes, insurance, utilities, repairs, and depreciation [if needed}). Your net income will usually be less than zero.

What you are NOT allowed to do, because it is your own home (you have "personal use") is claim a loss from this activity, to offset other income. Because of the "personal use rule", your deductions are limited to your income. Net effect ZERO.

It is possible for you to gain a positive tax effect from this activity; If enough of your schedule A deductions (mortgage interest &  property tax) are shifted to Schedule E, and your standard deduction becomes bigger than your itemized deductions, you will have effectively saved on taxes.

If you have no mortgage, then there could well be profit involved, which you may have to offset with depreciation that could lead to "recapture" in the future when the property is sold.

https://www.irs.gov/publications/p527/ch04.html#en_US_2014_publink1000219159

[Carl]

We bought a house this year and rent out two of the three bedrooms.

Your reference to "we" indicates to me that either you are married and you and your spouse purchased the house as your primary residence. It could also indicate that "we" are no married and from a business perspective you have a partnership.

Also I interpret your wording so as to indicate that you are renting out two of the bedrooms with the intent to make a profit. What matters here is "intent", and not if you actually do make a profit or not.

So can you please clarify just who "we" is? Then I won't waste your time with things that are a waste of your time.

[orlycpa]

Carl - thanks for the response! "We" refers to my spouse and I. No business involved.

We originally stumbled upon this living arrangement and had no intent of making it into a rental property, our purpose was to live in it but it was a bit high for our budget (but still a good deal) so we just decided to rent out the rooms. Then the landlord sold it to us, and we continued to rent out the rooms. Now that we own the property (as of this year) it occurred to us that maybe this money is now taxable... 

When the calculations are all done they pay us about 25k per year. They pay almost all of our mortgage (principal, interest, insurance, taxes). However they are each paying market rent for room rentals in the area. 

[orlycpa]

Hi Critter - thanks for your response.

Yes we have them all sign a lease (after a BAD situation awhile back where a roommate nearly destroyed the bedroom). The lease is just a basic "you agree to pay this amount and not destroy our place", etc. 

[orlycpa]

Hal_Al,

Thanks for the response. This is very helpful! I will look into this further. 

[ZTaxPro]

I think what you have described is a rental activity. You cannot say that the payments you receive from the tenets is cost sharing. You take a fixed amount for rent and then share other expenses, correct? You need to include in income the fixed amount for sure. If the IRS audited and saw payments coming into your account from tenets they would call this rent.

As for the percentage of common area expenses the IRS likes to see a reasonable allocation between personal use and the rental activity. Let's say that the rented area is 20% of the house, your private area is 20% and then the common/shared area is the remaining 60%. You could say that 50% (20% rented plus half of the 60% shared) is for the rental activity.