Does Roommate Rent Count as Income?
Navigate the financial and tax implications of receiving rent from a roommate, including reporting income and leveraging deductions.
Roommate rent can indeed have tax implications for homeowners and primary tenants. Understanding these implications is important to ensure compliance with tax regulations. The Internal Revenue Service (IRS) provides guidance on what constitutes rental income and how it should be reported.
Understanding Roommate Rental Income
When a homeowner or primary tenant receives payments from a roommate, these funds may be considered rental income for tax purposes. The IRS defines rental income as any payment received for the use or occupancy of property. This includes regular rent, advance rent, payments for canceling a lease, and expenses paid by the tenant on the homeowner’s behalf, such as utility bills.
A key distinction exists between genuine rental income and cost-sharing arrangements. If payments solely cover a share of household expenses like utilities or groceries, without intent to profit, they might not be taxable rental income. However, if the amount received exceeds a proportional share of expenses or is for exclusive or shared use of property, it qualifies as rental income. The homeowner or primary tenant then acts as a landlord, and payments for property use are taxable.
The IRS provides guidance on rental income in Publication 527, “Residential Rental Property.” If a property is rented for more than 14 days in a year, the income must be reported. Even if only a portion of the home is rented, payments received for that space are considered rental income.
Reporting Roommate Rental Income
When roommate payments constitute rental income, this income must be reported to the IRS. For most individuals, rental income and associated expenses are reported on Schedule E (Form 1040), “Supplemental Income and Loss.” This form is for reporting income or loss from rental real estate.
To report rental income on Schedule E, the gross rental income from the roommate must be entered. This includes all payments for property use, such as regular monthly rent, and any other amounts considered rental income. If services or property are received instead of money, their fair market value must also be reported. Each rental property, even a room, should have its income and expenses listed in a separate column on Schedule E.
Reporting focuses on the gross income received. For cash-basis taxpayers, which includes most individuals, rental income is reported in the year it is actually received, regardless of when it was earned. Accurate and complete reporting of all rental income is required to avoid issues with the IRS.
Deductible Expenses for Roommate Rental Income
Reporting rental income allows deduction of ordinary and necessary expenses incurred in the rental activity, which reduces taxable income. Deductible expenses include a portion of mortgage interest, property taxes, utilities, insurance premiums, maintenance costs, and depreciation. The IRS allows deductions for expenses directly related to managing and maintaining the rental portion of the property.
For shared expenses like mortgage interest, property taxes, and utilities, the deductible amount must be allocated between the rental and personal portions of the home. Allocation is based on the square footage of the rented space compared to the home’s total square footage. For example, if a bedroom is 10% of the home, then 10% of shared expenses can be deducted. Direct expenses, such as repairs to the rented room, are 100% deductible.
Depreciation is a deduction for rental property owners, allowing recovery of property cost over its useful life. It applies to the building structure, not the land, and begins when the property is ready for rent. Depreciation is reported on Form 4562, “Depreciation and Amortization,” and then transferred to Schedule E. Keeping detailed records of all expenses, including receipts, is important to substantiate deductions in case of an IRS audit.
Important Considerations for Roommate Arrangements
Renting out a portion of a primary residence introduces specific considerations beyond basic income and expense reporting. One area is the potential impact on the capital gains exclusion when the home is sold. Homeowners can exclude capital gains from the sale of their primary residence if they meet ownership and use tests, living in the home for at least two out of five years before the sale.
If depreciation was claimed on the rented portion of the home, that amount may be subject to depreciation recapture upon sale. This means it could be taxed as ordinary income. Recaptured depreciation is a factor to consider in the overall tax strategy.
Maintaining detailed records for all rental income and expenses is important. This includes rental agreements, bank statements showing rent deposits, and receipts for deductible expenses. These records are essential for accurate tax preparation and supporting claims during an audit. While renting a room offers financial benefits, it transforms a portion of the home into a rental activity, requiring careful financial management and adherence to tax regulations. For complex situations, consulting a tax professional can provide guidance and optimize tax outcomes.