Basically what he's saying is that you can treat the property as a duplex where you live in one unit, and rent out the other unit.
Or you can treat and report it as it's own physically separate rental property.
For the latter, you would allocate a percentage of your cost basis to that unit. Then report everything concerning that unit at 100% business use "as if" it was a physically separate piece of property. One area that can be problematic for some with this scenario, is if the utility costs are not metered separately between your living space or unit, and the rental living space or unit. Here's what I mean.
Your property taxes and mortgage interest deductions on the SCH E are limited to the percentage of the property that is exclusive to the rental. You can also only deduct on the SCH E that percentage of your homeowner's insurance equal to the percentage of rental space.
While the percentage of Mortgage interest and property taxes that do not apply to the rental portion are a SCH A itemized deduction, you have to prorate the insurance for the rental portion. What you pay for property insurance for the percentage of space that is not rental, is flat out not deductible anywhere on any tax return.
Then there's the utilities. How you split the utilities is not based on the percentage of floorspace. It's based on the total number of inhabitants that live in the house. So if you, your wife and two kids live in your "personal use" section and you rent the rental portion to a single renter, that's a total of 5 people. Therefore only 20% (one fifth) of your utility expenses are deducted as a rental expense on the SCH E..... and only for those utilities that are truly shared with the tenant. Then to further complicate this, if you only have one landline telephone in the entire property, not one penny of your phone bill is deductible as a rental expense - even if that line is "shared" with the tenant.
For other utilities, (gas, water, electric, cable, internet) they must be shared with and accessible to the renter for you to claim any percentage of those expenses on SCH E. That doesn't mean the tenant has to actually use them. It means they must be "accessible by and available to" to the tenant. Here's an example:
The rental portion of your property that is "exclusive to the renter" does not include a laundry room. So you and the tenant share the same laundry room washer and dryer. That laundry room can not be included in the percentage of space that you claim as a rental, since it's not "exclusive" to the renter. But using my numbers above, 1/5 (20%) of your water and electric bill is a deductible expense on your SCH E.
So it is for these reasons pointed out above, that you want to ensure things like this are covered in your rental agreement with a tenant. That way if ever questioned by the IRS or audited on your SCH E expenses, you have something "in writing" to show your right to claim that rental expense.
On a side note just to cover yet "another base", if you are renting to a single person and they have a child, note that in the rental contract that the child (or other dependent) is "in fact" living in that space. If this were the case with my scenario above, that would be you have a total of six people living in the structure with two of them being tenants. That means you can claim 33% (one third) of your utility expenses on the SCH E.
