Renting bedrooms tax question

Since you have two separate rooms with two potential tenants staying different amounts of time, you should list each separately.

 

Divide by square footage. Common areas are considered personal use. If the entire property is 1000 square feet and each room is 100 square feet, give 10% of each expense to each room. This only counts if the property is in service, meaning rented or available to be rented.

Since you have two separate rooms with two potential tenants staying different amounts of time, you should list each separately.

 

Divide by square footage. Common areas are considered personal use. If the entire property is 1000 square feet and each room is 100 square feet, give 10% of each expense to each room. This only counts if the property is in service, meaning rented or available to be rented.

This post is lengthy. But it contains important information that you need. Doing things wrong in that first year of dealing with a rental is not an option. Perfection is a must. Even the tiniest of mistakes can (and will) grow exponentially over time. Then when you catch the error years down the road (usually in the tax year you sell the property) the cost of fixing it will be expensive. So a bit of work on your part now, will save you a massive headache, as well as your wallet, later.

Example. You are renting out two bedrooms in your house to two completely different and unrelated persons. Each bedroom occupies 10% of your total floor space. So together they occupy 20% of your total floor space. You will have "ONE" rental on the SCH E for this, and "TWO" assets for that one rental, with each asset being one of the bedrooms. There is a reason I am recommending this method, that I will cover later.

Start working through the Rental & Royalty Income (SCH E) section of the program. Below, I am only addressing those screens that matter.

- On screen, "What type of rental is this?" select single family home.

- On screen, "Do any of these situations apply to this property?" you will select three items.

• 2021 was the first year I rented this property
• I rent out part of my home
• I converted this property from personal use to a rental in 2021

- On screen, "Was this property rented for all of 2021?" if you started renting the rooms at any time in 2021 (doesn't matter if you started on Dec 30, 2020) and the rooms were still classified as rental space on Dec 31 of 2021, select YES for both questions. The program will base your allowed deductions starting on the date you placed the asset "in service" as rental property, and you will enter that date later, and you will enter that date more than once.

- On screen, "do you have an office in your home?" Be aware that a home office is not allowed for residential rental real estate. So you'll select NO on this screen. However, if you have a SCH C business and claim a home office on that SCH C, then (and only then) would you select YES. I am going to assume you select NO.

- On screen, "Let us calculate your expenses for you." select NO. The problem with selecting yes, is that the program does not calculate everything "correctly", and there are still some things it still flat out can not calculate at all. You want to do this manually, because perfection on the SCH E in your first year is not an option.... it's a must. Even the tiniest of mistake can (and will) grow exponentially over time. Then when it's caught years down the road, the cost of fixing it will be expensive. So do a bit of your own brain work now, to avoid being forced to deal with it (and the IRS) later.  It's a one time process, and you're done.

- On screen, "Tell us about the property" where it asks if the property was your residence in the past, select yes.

- On screen, "Enter purchase price" enter what you paid for the property in full, when you "originally" purchased the home all those years ago. In this figure, you should also include the cost of any property improvements that you paid for before you converted the rooms to rental. For the available date, enter the date you converted the rooms to rental. Typically, this will be the first day that a renter "could" have moved in.  The purchase date will be the date you closed on the original loan when you originally purchased the property.

- On screen, "Enter Fair Market Value" enter the FMV of your house on the date you converted the rooms to rental. Typically, this value will be "HIGHER" than the original price you paid for it. So I fully expect (and will assume) that the value you enter on this screen, will be higher than the value you entered on the screen for "Enter purchase price".

- On screen "enter escrow fees", enter these numbers from the HUD-1 Settlement Statement or the ALTA settlement statement you were given at the closing when you originally purchased the property.

- On screen, "Any seller paid points?", if the seller paid any points "for you", that will be on the line item for points, under the "paid by seller" column. This is not common, but not unheard of either.

- On screen, "Any property improvements made?" I would fully expect you already included the cost of any property improvements, in the purchase price you entered on the screen for "Enter Purchase Price". If you did, then leave this blank. If you did not, then enter the cost of any property improvements here.

- On screen, "Enter property tax values", get these values from the most current property tax bill you have in your possession. I would expect that to be your 2021 property tax bill.

- On screen, "Depreciation Results" these numbers are flat out wrong. But don't worry, we'll correct it later in the assets/depreciation section. When you click the continue button on this screen, you are returned to the "Review your [propertyname] Rental Summary" screen.

- In the rental income section enter the total rental income received from all sources for the two rooms rented in 2021.

- In the rental expenses section you will enter your costs directly related to the rented rooms. Some things have to be pro-rated and I'll cover that now.

• Insurance - you can enter the percentage of property insurance you paid, that is equal to the percentage of floor space rented. For example, if you are renting out 20% of your floor space and you paid $1000 for property insurance in 2021, then you can claim $200 for insurance, since $200 is 20% of the $1000 you paid.  The remaining $800 of your insurance payment is not deductible anywhere on your tax return.
• Repairs: You can claim 100% of repair costs provided the repair expense incurred related to something that was 100% rental use. For example, if the $25 door handle broke on the bedroom door, that would be 100% deductible as a rental expense, since that door is used exclusively by the paying renter. You can claim a percentage of the repair expense for repairs that affect the renter, but are not exclusive to the renter. For example, if the $25 door lock on the front door broke and was replaced, you can claim as a rental expenses a percentage of that cost that is equal to the percentage of floor space being rented by the tenant. In my scenaro that would be 20%, or $5.
• Real Estate Taxes: You can claim a portion of your real estate taxes that is equal to the percentage of floor space rented out, further reduced by the period of time the room was classified as a rental. For example, say I paid $1000 in property taxes in 2021. With 20% of my floor space rented out that would be $200 I can claim on property taxes. The room was converted to a rental on 7/1/2021, so it was only classified as a rental for 6 months. $200 divided by 12 gives me $16,66 a month. Multiply that by the number of months rented which is 6 months in my scenario, and I can claim $100 for my property taxes on SCH E. The remaining amount is deductible later on SCH A as an itemized deduction.
• Utilities: To start, understand that if you have one landline telephone in your home, you are not allowed to claim any amount of your phone bill on SCH E. Not a single penny. The IRS says so. But if you have two land lines "and" one of them is exclusive to the renter, then you can claim 100% of the cost of that line only, as a SCH E rental expense.  Now utilities includes the cost of LP Gas, electricity, water, cable/satellite TV and Internet. There are two ways you are allowed to figure the SCH E portion of these expenses. But for now I"m only going to cover what I consider the simpler way, which is based on percentage of floor space you have rented. SO if you're renting 20% of your floor space, only 20% of those bills are deductible on SCH E, starting on the date the room was converted to a rental. So it may not be 20% of your utility costs for the entire tax year. Additionally, to claim the utility expenses on SCH E for cable/satellite and Internet, it must be available for "exclusive use" of the tenant. So if you have a cable drop and/or satellite box in the tenant's room, that's exclusive to the tenant. If you do not have a cable drop/satellite box in the tenant's room, it's not exclusive to the tenant. If you are providing wireless internet access to your tenant, then that's considered to be exclusive to the tenant regardless of where the access point is in your house. Otherwise, if only hard wired internet access is available, then you must have a physical RJ-45 drop in the tenant's room for the tenant to plug into, and obviously it has to work. 🙂  So you'll total up your utility bills from the date the room was converted to a rental, and then claim a percentage of that total on SCH E, that is equal to the percentage of floor space rented out.

- On screen, "Report Mortgage Interest" start with the amount in box 1 of the 1098-Mortgage Interest Statement you received from your mortgage lender. Multiply that amount by the percentage of floor space you are renting to the tenant. Now divide that by 12 to get the mortgage interest for each month. Now multiply that figure by the number of months the room was classified as a rental. This gives you the total amount of mortgage interest you can claim on the SCH E. The remaining amount is claimed later in the program as a SCH A itemized deduction. So write that amount down so you have it when you need it later in the program.

- On screen, "Any miscellaneous expenses?" If you pay HOA dues, then you can claim a percentage of that equal to the percentage of floor space rented to the tenant, further reduced by the number of months the room was classified as a rental. This completes the expenses section. Now move on to the Assets/Depreciation section.

- If prompted to go directly to your asset summary, select yes and continue.

- On the "Your property assets" screen you see your property itself listed there, with a depreciation amount. That depreciation amount is wrong, and is way to high. (Don't worry, I'll prove it's wrong as we work this through)

- Elect to edit that entry.

*- On screen "Describe this asset" select Rental real estate property, and continue.

- On screen "Tell us a little more about your rental asset" select Residential Rental Real Estate, and continue.

- On screen, "Tell us about this rental asset?" The numbers you see there should all be correct, as you entered them when you started the SCH E data entry process. No need to change them. Just continue.

- On screen "Tell us more about this rental asset" select that you purchased this asset. Then below that select "No, I have not always used this item 100% of the time for this business. Then below that select "I used this item for personal purposes before I started using it in this business" Then below that, "Date I started using it in this business" should already be filled in with the date you converted the room to rental use.

Below that it reads, "Percentage of time I used this item for this business in 2021 (e.g., 80%)"

THIS IS THE WRONG QUESTION, AND IF ANSWERED AS IT READS YOUR DEPRECIATION WILL BE WRONG!

The question is wrong only for your specific and explicit situation, because your entire house is not 100% business use. What this question should be asking you is, "percentage of floor space that is exclusive to the renter".

Now you said that you wanted to claim each room separately. You can do that here. As I understand it, each room is 10% of your floor space. So with two rooms, that's 20%. We'll make this asset entry for only one of the rooms. So just enter 10% here, then continue.

On screen, "Asset Summary" you need the amount of depreciation deductible for this one room, which is 10% of your structure value pro-rated for the number of months it was classified as a rental.  You can click the details checkbox if you like, to see the details. I recommend you print this screen, as you are going to need this data for entering another asset, which will be the other bedroom you are renting out. Once done viewing this screen, click continue. This returns you to the 'Your property assets" screen.

- On screen, "Your property assets" click the Add an Asset button.

Now go back up in this post to the line that starts "*- On screen "Describe this asset" select Rental real estate property, and continue."  Note that there is an asterisks (*) at the start of the line above where you need to start from, and enter the same information again as another new asset. The only thing that will be different is the third screen in called "Describe this asset". Your description for the 2nd room can not be identical to the description in the first asset. So call it something like "Bedroom 2" or whatever. Just work it through and all of the data entered will be identical to all the data in the first asset listed.

When done, you'll be back to the "Your property assets" screen, and you should see two entries on that screen now, and assuming the percentage of floos space is the same for both rooms, the depreciation shown for each should be identical. If we're good, click the DONE button. This returns you to the "Review Your [propertyname] Rental Summary" screen.

ON that screen next to Assets/depreciation, you see the total depreciation amount based on your total percentage of floor space that is classified as rental. Now lets confirm beyond a doubt that amount is correct.

Go to IRS Publication 946 at https://www.irs.gov/pub/irs-pdf/p946.pdf  Use the worksheet that starts on page 37 of that document to manually figure the depreciation. For line 4 of that worksheet, it's 27.5 years. For line 6 of that worksheet use table A-6 on page 72.

If your figure is off by a buck or two, that's fine. You manually figured using exact numbers. The program incorporates the IRS requirement to "round to the nearest dollar". So if there's a buck or two difference, that's perfectly fine. Just leave it alone and you're good to go.

 

One advantage you have by splitting the two rooms into physically separate assets, is that if later down the road you need to convert one of the rooms back to personal use, you can do so quite easily without having to jump through hoops of fire over a burning lava pit.

 

 

 

Thanks Carl for the detailed response this truly is the best answer!!! I am going to follow this suggestion and restructure my rental with each bedroom being a different asset. I have a few hours before the deadline to make the changes

Just wanted to clarify the reason I need to select "I converted this property from personal use to a rental in 2021" . 
Does this statement still apply if I live in the house and am renting two bedrooms to two separate people.

Does this statement still apply if I live in the house and am renting two bedrooms to two separate people.

Yes. Later, you will be indicating the percentage that was converted. You've a ways to go first. Just work it through. As questions arise, chances are it will be "answered" later.

Another thing I wanted to clarify is only in the "Your property assets" page  I have two assets one for each bedroom? Both were placed into service on the same date. I let the first candidate choose which room he wanted both were available. Upon renting the first room I was still in search for a renter for the second room.

Another thing I wanted to clarify is only in the "Your property assets" page I have two assets one for each bedroom?

Technically, you could just enter one entry showing the entire 20% for both bedrooms as a single asset. But there's a reason I had you separate the bedrooms out.

The reason I had you set it up that way, is so that if for example, in the future you need to convert only one of the bedrooms back to personal use, then you can do so without screwing up things like the depreciation history. Additionally, if you wanted to add another room later down the road, then you can do so with ease and not mess up the existing history.

In other words, it gives you versatility down the road if things change, so you don't have to jump through burning hoops of fire over boiling lava pits to deal with those changes.

Nearly finished!
Regarding the mortgage insurance expense calculation seems this is meant to be form room a and b together not separate? Room a is 5.1 percent and room b is 7.1 percent. I currently am using the percentage sum to calculate the mortgage insurance expense. Mortge Insurance Expense = Mortgage insurance whole year * (sqft percent room a + sqft percent room b) / 12 * months in service of room a and b for 2021. Room a and b has the same months in service in 2021

In the "tell us about your rental asset" page the values of cost and cost of land are slightly higher than the sales price of the house and land value shown on the tax bill is this expected? I financed the property through a mortgage and previously entered some costs in the disclosure in the questionnaire ( legal fees, title insurance etc.) likely why this page has the numbers adjusted up a bit (few thousand).

One more follow up
I selected yes in the "Did you refinance screen" 
There is a "Enter your loan information" screen following would the rental use percentage be the same sqft percentage I put down elsewhere? 5.1 (room a) + 7.1 (room b) entering 12.2 for rental use percentage

Thanks for the explanation on why we are making each bedroom a separate asset in terms of depreciation makes sense for the flexibility in the future.

When on the "Report mortgage interest" page I actually have three 1098 forms with mortgage interest. Would I apply the same math you mentioned for prorating the mortgage interest on each individual 1098 form and have three entries on this screen. my formula is mortgage interest * .122 (room a + b sqft percentage) * 6/12 (percent of year in service)

Regarding the mortgage insurance expense calculation seems this is meant to be form room a and b together not separate?

I'm sure you meant to type mortgage interest expense. That is correct. Remember, you're entering expenses "outside" of the assets/depreciation section. So the expenses section covers the expenses for the total of all assets in the assets/depreciation section. (In your case, your assets are the two rooms.)

 

Room a is 5.1 percent and room b is 7.1 percent.

So your total percentage of floor space that is rental property (business use) is 12.2%.

I currently am using the percentage sum to calculate the mortgage insurance expense.

Again, I assume you mean mortgage interest. But you'll use the same math for the property insurance.

Mortge Insurance Expense = Mortgage insurance whole year * (sqft percent room a + sqft percent room b) / 12 * months in service of room a and b for 2021.

I assume we're thinking the same way, except that you keep using the word "insurance" when you really mean "interest".

Room a and b has the same months in service in 2021

So it's total mortgage interest paid for the entire year, divided by 12 months. This total gives you the "per month" average interest paid. Multiply that by the number of months the rooms have been classified as a rental. Then multiply that by 12.2% to get the amount of mortgage interest to claim on SCH E. Then write down the difference, as what's left is a SCH A itemized deduction, which you'll deal with later under the Deductions and Credits tab. (Long after you've completed this rental stuff)

In the "tell us about your rental asset" page the values of cost and cost of land are slightly higher than the sales price of the house and land value shown on the tax bill is this expected?

Yes. Under no circumstances can you use the "tax values" for figuring your cost basis in the property. That's because typically the tax value assessed by the county tax appraiser is 30% or more below the FMV of the property. Confused now? Good! Means you're paying attention! Let me explain why the program asks you for tax values.

I'll use the format of my own tax bill to explain, and will use simple numbers so that it's easy to "do the math" in your head.

On my tax bill it shows the "value of the land" at $25,000 and the "Value of all structures" on that land at $75,000. So my total tax value is $100,000. But wait! I paid $200,000 for my property!  The program uses the tax bill values for the sole and only purpose of determining what percentage of my total tax value, is for the land. Simple math indicates that 25% of my tax value is applied to the land.

So in the COST box I enter the total I actually paid for the property, which is $200,000. Then for "COST OF LAND" 25% of $200,000 is $50,000. So I enter $50,000 in the COST OF LAND box. From there, the program (not you) will "do the math" in the background, without bothering you, and will depreciate $150,000 over the next 27.5 years.

Now in your case, since you're only renting out 12.2% of your property, I don't know if the amounts in the COST and COST OF LAND box will be 12.2% of the totals, or if it shows the actual figures and just figures that 12.2% in the background.

As you work through the asset and get to the asset summary screen for the room that is 7.1%, I would expect it to show the amount being depreciated as 7.1% of the allocated structure value.

I financed the property through a mortgage and previously entered some costs in the disclosure in the questionnaire ( legal fees, title insurance etc.) likely why this page has the numbers adjusted up a bit (few thousand).

That's exactly why. Generally, here's how it works with your sales expenses.

Those expenses related to acquisition of the property are added to the cost basis of the property An example of this would be the title transfer fees paid at the courthouse to replace the seller's name on the property deed, with the buyer's name.

Those expenses related to acquisition of the loan are amortized and deducted (not depreciated) over the life of the loan. An example would include points paid at the closing, and other financing fees charged by the lender. 

Typically, you will see your financing fees in the assets depreciation section also, entered an an amortized intangible asset. But to be honest, I don't know quite how that works since you only rent out "a part of" your primary residence. I would not expect 100% of those fees to be deductible, and for all I know since the property is not 100% business use, maybe only some of them are, or none of them are. But when it comes to that, I've not yet had any reason to not trust the program on that particular item.

Now I'll end this particular post with one of my most favorite quotes of all time, since it fits. 🙂

* Those who claim the situation and all aspects of it, are obviously not paying attention*

When on the "Report mortgage interest" page I actually have three 1098 forms with mortgage interest. Would I apply the same math you mentioned for prorating the mortgage interest on each individual 1098 form and have three entries on this screen.

You are correct. Point of order here though. It "sounds" like two things happened in 2021.

1) Your mortgage was sold to another lender. Therefore you got a 1098 from the "old" lender, and another from the "new" lender that purchased the mortgage.

2) You refinance the property in 2021.

If I'm not correct on the above, then let me know why you have 3 form 1098's for that property, in chronological order. Also, if you did refinance, it matters if you refinanced with the same lender, or a different lender in 2021 "only" if you show an item in the assets/depreciation screen for an amortized intangible asset. (which would be your financing and/or refinancing fees.)

 

I followed the IRS worksheet that you referenced in the irs publication and line 15 was almost identical the value which turbo tax is using for depreciation. Within $1

I expected it to be less than $2 difference. So it looks like you're good to go. I would suggest  you "sit on it" for about an hour or more before you e-file, just in case an "oh I forgot something!" moment strikes. Otherwise, if you need to amend you really can't even start the process until after your currently e-filed and accepted tax return is processed completely. That can take a few weeks.

 

@Carl Really appreciate your thorough explanations to this question from last year. I'm having trouble in a similar way this year with TurboTax Online's line of questioning -- it is clear to me the depreciation value being calculated is on 100% of my property, not on the 25% it should be (I rent out 25% of my home). I wonder if language has changed slightly from last year?

 

I'm not seeing any page entitled "Asset Summary", or a way to fill in a "percentage of time I used for this business" (as a way to trick the software by filling in "percentage of home rented"). Instead, I'm seeing a chance to enter "number of days for rental use" and "number of days for personal use" together. When I try to trick the software as you recommended (entering 91 days for rental, a.k.a 25% of 365, and 273 for personal, a.k.a. 75% of 365), the software automatically prorates all of the expenses I manually entered.

 

What are my options here? Am I missing something in this year's software that has fixed the problem you wrote about here last year? Or should I put in the full (100%) amounts on each expenses, let the software prorate them based on the 91 days I entered (even though it wasn't 91 days, it was 365 days of 25% of my home) -- would I then end up with correct expenses and depreciation? Or would something still be off?

 

Thanks!

@vinceation Number of days of rented will be the number of days rented. Plain and simple.

Number of days of personal use will be ZERO. It's asking for the number of days of personal use of that 25% converted to a rental, *after* you converted it to a rental. So that will be ZERO. If you make it anything more than zero, that "will" affect the total of your rental expenses for that 25% that you are allowed to deduct, and it will also reduce the amount of depreciation you are allowed to take on that 25%.

Hopefully, that gets you on the right track now.

 

Thanks @Carl. I think I need to provide a little more context. My specific issue is that I began renting 25% of my home this year (the other 75% is personal use), and although TurboTax can correctly calculate all of the way expenses are affected by that 25-75 split, the depreciation / asset calculations are definitely too high (which is what brought me to your comment 👆 from last year) — the software is clearly calculating depreciation for 100% of my house, not 25%. Any ideas on what to do with this?

Hang on. I'm working it through my desktop 2022 version of the software.

 

Okay, I've worked it through and it really doesn't appear much has changed. Here's the steps, assuming you have already entered the asset in the Assets/Depreciation section.

- In the Assets/Depreciation section elect to edit the asset.

- On Describe This Asset, select Rental Real Estate Property and continue.

- On Tell Us A Little More...." select Residential Rental Real Estate, and continue.

- On Tell Us About This Rental Asset, enter the description, cost, cost of land, and the date you "originally" purchased the property. Then continue.

- On Tell Us More About This Rental Asset, select that you purchased new, and no, I have not always used this item 100% of the time for business.

 - Still on the same screen, enter the date in 2022 that you first started using this as a rental. Typically, this is the first day a renter "could" have moved in, and this date needs to be the same date you entered earlier, (If you were asked this same question earlier.)

 - Now at the bottom where it asks for percentage of time, do *not* enter percentage of time. Instead, enter percentage of floor space. Then continue.

The figures "should" be right now, presuming you elected to have the program "do the math for you" at the start.

If the depreciation is not right, then you most likely elected to do the math manually yourself. In that case, for your COST and COST OF LAND, you would enter 25% of your cost basis for those items. (Assuming you have converted 25% of your floor space to rental.) Remember, COST OF LAND *is included* in the amount you enter in the COST box. The program (not you) will subtract the cost of land from the cost, to get the value of the structure for depreciation purposes.

 

-

@Carl Wow, I so appreciate how thorough and quick-responding you are - thank you! If I can bug you just a bit more; I’m struggling to find the pages you’re describing where I get “describe this asset” and have the option to choose “rental real estate” - Perhaps because I’m using TurboTax Online? Or perhaps because I’m looking in the wrong place. I’m looking in the Rental & Royalty Income section, and below entering the income and expenses, I have the option to add assets. I have added “new rental”, which begins me in the questionnaire to determine depreciation (and which never prompts me with the questions/options you have written here).

thank you!

Perhaps because I’m using TurboTax Online?

Yep, that's why. I've never used online.

I have the option to add assets.

I would think that if you have the option to "add assets", instead of the option to edit an already entered asset, that would indicate to me that you haven't entered any assets. So if the property asset does not exist yet, you definitely need to enter it.

For me, on the rental property summary screen my selections are Rental Income, Rental Expenses, Assets/Depreciation, and Vehicle Expenses. The "Assets/Depreciation" section in the CD version  is where I'm going.

Upon selecting the Assets/Depreciation section, if there are not already assets there, then I get the screen to enter my first asset. Otherwise, if assets are already there, they're listed for me with an option to edit each listed asset individually, and a separate button to "Add Another Asset".

 

Okay thanks for this help. I’ll see what I can figure out from Quick Books online help, maybe.

 

Really appreciate the help!