My questions are to seek understanding of tax rules that would apply regarding passive income for renting out a spare bedroom in the house I reside. I need to file back taxes for 2020 even though I’ve been told I shouldn’t need to due to the little bit of rental income I earned that year, because I took IRA withdrawals which were qualified. The IRA withdrawals are not the subject of the questions though as I won’t owe taxes from the ROTH IRA withdrawal due to total disability and a letter from my doctor. However, I am stumped due to the fact that I rented out a spare room for the first 3.5 months of 2020. Even so, I won’t ultimately owe taxes, because my regular income is nontaxable disability income.
Pertinent BACKGROUND: In 2020 and 2021, I rented out the bedroom until some point in April 2020, for less than 10 consecutive months spanning the two years. I did not rent out the room in 2021 or 2022, nor so far in 2023. I’m considering whether to rent out a spare bedroom at the end of this year or possibly in 2024. To complicate matters, I think I would rent out a different spare bedroom, with a smaller square footage. It would be a long-term rental to help share/off-set expenses. Fair market value to rent a spare room out of a house where the kitchen, living spaces, and possibly bathrooms would be shared is far less than fair market value for a 1-bedroom apartment where someone has privacy and does not have to live with their landlord. I point this out, because when I last checked the link in TurboTax was only displaying FMV for a 1-bedroom apartment which no one is going to be able to get for renting a spare room in the landlord’s house. As a result, because my disability income is tax free, if I were to collect 12 months of rent in one year, even before deducting expenses, my rental income would be below the standard deduction. In 2020, I was “head of household.”
#1 Group QUESTIONS Regarding “Not for Profit” vs “For Profit”: I read if I claim to have rented “not-for-profit” the IRS can look back 5 years. If they see profits in 3 out of 5 consecutive years there can be a problem. Would that have to be corrected somehow retroactively? On the other hand, if I claimed I rented for profit and did not turn a profit would I have to correct that retroactively? I imagine this could be expensive if I had to enlist the help of a tax professional due to multiple years of taxes would be involved. I’d rather avoid that problem, but it can be difficult to know in advance if there will be a profit. Since I rented for part of 2019 (Year-1) through part of 2020 (Year-2), but did not rent at all in 2021 or 2022 (Years-3 & Year 4?), if I resume renting this year in 2023 would that be Year-5? Or, would the fact that I did not rent out a room at all in 2021 and 2022, and then did not resume renting until sometime in 2023 mean the IRS will begin over and count 2023 as Year-1?
#2 Group Questions Pros and cons of renting “for profit” versus “not for profit: What are the advantages versus the disadvantages to renting “for profit” versus “not for profit?” What would the tax considerations, or different “tax treatment,” for “for-profit renting” versus “not-for-profit renting? Am I correct that I would not use a “schedule E” if it was “not for profit” activity? I realize one way to make sure it is “not-for-profit” would be to spend a larger portion of the rental money that year repairing, improving and/or maintaining the property to up my expenses. On the other hand, if I claimed I rented “for profit,” but instead realized losses, I’ve read I can carryforward those losses to the subsequent year to offset income. How far forward can those losses be carried, and can they be carried forward even if there is an interruption in rental activity where there is a year or two in between when there is no rental activity/income? Considering I will be devoting minimal time to renting out the room, and I won’t provide any services would the carried forward losses just offset the rental income or could it offset other or total taxable income as one day I might benefit from a small potential future pension, or possibly I might have earned income someday if/when I can work part-time. Thus, I'd like to know if I do have taxable income in the distant future, would any losses be able to offset future income from a pension or part-time job, or would the losses only apply to offsetting rental income? If I ever decide to rent more than one room there could possibly be enough income to owe taxes based on rental income, so either way I'd like to know if any losses can be carried forward beyond one year, and even if there's an interruption where I didn't rent out for 1 to 2 in between years. For instance, if I rent for year 1 and incur losses, can I then use year-1’s losses to offset year-4’s rental income if I had no net gain or positive rental income to offset in years 2 and 3, and would I only be able to do that if I had also rented out a room and earned rental income in year 2 or year 3, or could I apply year-1’s losses to offset year-4s income even if I did not rent out a room at all in year 2 and year 3?
#3 Group QUESTIONS Regarding depreciation + for profit versus not-for-profit rental activity: Does renting “for profit” versus “not-for-profit” in any way determine if I am supposed to depreciate the room rented, and/or does it affect whether the depreciation will be “recaptured” by the IRS when I go to sell the house? I’ve read that if I could have claimed depreciation even if I didn’t claim/capture it for a particular tax year, the IRS will expect to recapture it when I sell the house. If I recall correctly, the IRS recaptures the depreciation by lowering the amount that is eligible for the capital gains tax exclusion from the sale of a house by the amount of depreciation that could have been claimed/reported/deducted even if I did not claim depreciation. However, am I supposed to calculate and report depreciation for years when I would owe no taxes thus cannot monetarily benefit in any way from depreciation, or “capture the depreciation?” If I don’t have to report the depreciation if I would owe no taxes so cannot benefit from depreciation will the l the IRS “recapture the depreciation” when I go to sell the house even if I did not report it during the previous tax year/s? If I am supposed to report depreciation even if I cannot “benefit” or “truly capture” the depreciation during those tax years due to no net gain rental income, or a low income below the standard deduction, even before applying/deducting depreciation, then when I go to sell the house, considering I did not monetarily benefit, or “capture,” the previous reported depreciation for past years will the IRS expect to “recapture” depreciation for the past years I rented out a room even though I never “captured” or monetarily benefited from depreciating the room?
In my circumstances – setting aside the year I took out an early IRA withdrawal – am I required to file taxes if I rent out a room where the income is below the standard deduction? If I am not required to do so, should I anyways? Is there a reason I might want to ,file taxes anyways? For example, when I eventually sell the house would I then report any year I obtained passive rental income, and would I then have to report depreciation I “supposedly could have claimed” even though “I could not benefit from claiming depreciation,” and would the IRS then expect there to be “depreciation recapture” - from depreciation I never could truly capture in the first place – to offset the capital gains exclusion when I sell the house? I’m trying to figure out if rental activity does not have to be reported for the tax year I rented out a room due to me not owing taxes that year, but if so would there likely be a time in the future where I would have to report the rental activity and depreciation for back years such as when I sell the house, or even if circumstances change and one day I did owe taxes for a year I rented out a room? In such a case the problem would be when reporting depreciation and tracking what year of 27.5 years the room was being depreciated. I don't really know how that works. I know I would have to file taxes then for the year I owed taxes, but how then to track depreciation if I did not file taxes for previous years because I did not owe taxes during those years? The same problem could exist if I needed to depreciate a dishwasher or furnace I had purchased a couple years prior. It seems then I might have a major headache trying to do taxes in the year I did owe taxes.
I have read somewhere that if “I could have claimed depreciation” the IRS will expect to “recapture it” when I sell the house even if I did not claim depreciation during the past tax years, but I don’t know if that would apply for years when there was no net gain in income, or when the gain was too low to benefit from claiming depreciation. When I sell the house, will the IRS expect to “recapture” the depreciation by offsetting the capital gains exclusion amount even though I could never really take/benefit from/ or capture that depreciation during past tax years due to either no net gain in rental income, a loss in income due to high expenses, or a very low taxable income below the standard deduction and would this be the case regardless of if I had reported the depreciation during past tax years or not, such as even if I did not report depreciation during past tax years due to having negative or no rental income and/or very low taxable income below the standard deduction even before considering depreciation?
#4 Group Question – Regarding depreciation when skipping years of renting: If I file taxes in Year-1 and Year-2 and report rental income from spare “bedroom A,” then in Years 3, 4 and maybe even Year-5, I do not rent out a room, thus there’s no rental income, and I owed no taxes thus I did not file taxes for those years, how does the IRS determine years later when I sell my home for which years they should recapture depreciation for “bedroom A?” Even if you tell me they will recapture the depreciation for Years 1 & 2, even though I could not benefit from the depreciation due to such low income, it would certainly be unfair if the IRS would “recapture depreciation” on the room for years I did not actually even rent out the room so how would the IRS keep track of that if I don’t regularly file taxes because I don’t owe taxes or usually don’t owe taxes. Furthermore, I am considering not even renting out the same bedroom later this year or next year but renting out an entirely different bedroom with a smaller square footage. How would I show that “bedroom A” was rented in years 1 & 2, no bedroom at all was rented in years 3 & 4, and in year 4 or year 5 I resumed renting but rented out an entirely different bedroom – “bedroom B” – with a smaller square footage? I don’t want a situation where even though there were multiple years where neither room was being rented out, and there were multiple years where only one room was being rented out, the IRS expects to recapture depreciation on two rooms for many consecutive years up to 27.5 years for each room when maybe one room was only rented out for one or two years, and neither room was rented out for most of the years. Is avoiding this confusion a reason to file taxes even when I don’t owe taxes - just to show the years bedroom B and/or bedroom A were in and out “of rental service” so the IRS knows for what years and for what bedroom to expect to recapture depreciation, or do I cause more confusion by filing taxes in years I don’t owe taxes, and if so how is it all sorted out in the end when I sell the house?
