Investors & landlords

When it comes to entering my information in TurboTax, my plan is to treat the rental as a completely separate property and value the rental structure using the percentage of total square feet method. How do I treat shared expenses like real estate taxes and mortgage interest?

To me, that's the simplest way to go for your situation. For those things that are shared (property taxes, water and the such) you'll split them using the same percentage as you will/do for floor space.  There's some important things to note about this also that makes it "very" important to pay attention to detail on each and every screen as you work it through.

I suggest you let the program do the splits for you by selecting that option when you get to it. But understand that the program can't split everything.

Keep in mind the math is not as simple as one would first think, for those things you have to figure manually. For example, if 30% of the floorspace is rental, then 30% of your water bill can be claimed as rental expense. However, if the rental did not become "active" until July 1st, then you can't claim 30% for the entire year. You'd have to add up those water bills from July thru Dec and claim 30% of that only.

 The program will split the mortgage interest and property taxes taking into account your "in service" date with no problem. It will "NOT" split the property insurance. That's because the property insurance you pay on your primary residence is not deductible anywhere on your tax return. Period.  Now you can deduct that percentage of your homeowner's insurance that applies (equal to percentage of rented floor space). However, since homeowner's insurance doesn't cover rental property, if the IRS questions this, rest assured you will lose.

Basically, so long as you don't claim anything on your taxes that would "raise flags" with the IRS, they'll not question it so long as you don't give them reason to do so. I've known folks in your specific situation where they didn't realize they needed a separate policy for the rental and had claimed part of their homeowner's insurance on SCH E. The IRS has no way of knowing they did that, and there was nothing else "questionable" on the return from the perspective of the IRS. So they basically got away with it for that year.

But where you most definitely won't get away with it, is if you file a claim on the rental unit. Not only will the insurance company not pay since the property wasn't being used for it's insured purpose, when the mortgage holder finds out (and they will because the insurance company will tell them) as far as the lender is concerned the property (or portion thereof) was uninsured and you'll be dealing with some hefty fines from the mortgage lender for having violated the terms of your lending contract.

One final thing too. Once you figure the percentage of floorspace that is exlusive to the renter, you'll allocate that same percentage of the land value to the rental also. We both know that land isn't depreciable and technically it makes no difference. However, having a zero for the value of the land is one of those "flag raisers" with the IRS, and you want to avoid that, of course.

Now pay attention as you work this through. Since you'll be selecting the option to indicate you rent a part of your home, when it gets to the expenses section you'll be asked for two types of expenses.

First, there's "whole house" expenses. The only expense you'll enter there (that I"m aware of at this time) will be the water bill. The program will do the split for you to figure the percentage of what you enter that is a rental expense. For the other utilities and expenses you'll enter a zero for the whole house expense.

You'll also be asked for "rental portion only" expenses. That would be those expenses that are exclusive to the rental only. For example, since electric is metered separately, if you pay that bill then what you pay would be entered as a "rental portion only" expense.

Whew! Confused yet? I'm not, but can only imagine how all this info is probably scrambling your brain right now. 🙂