Renting Out a Room in Your Primary Residence: Tax and Depreciation Tips

Renting out a room in your primary residence can be a practical way to generate additional income, but it comes with tax implications that homeowners must address. Understanding the financial aspects, including property cost allocation, depreciation, and income reporting, is essential to ensure compliance with tax regulations and maximize financial benefits.

Determining Rentable Area

Accurately identifying the rentable area is a key step in calculating tax-related figures. The IRS requires homeowners to define the portion of their home used for rental purposes, typically by calculating the square footage of the rented space as a percentage of the total home area. For example, a 200-square-foot room in a 2,000-square-foot home constitutes 10% of the property. This percentage determines expense allocation and depreciation.

If tenants share spaces such as kitchens or living rooms, those areas may also factor into the calculation. The IRS permits a reasonable allocation based on the tenant’s usage. For instance, if a tenant uses the kitchen 50% of the time, you might allocate half of the kitchen’s square footage to the rentable area.

Allocating Property Costs

Property costs must be divided between expenses specific to the rented space and those shared across the home. Direct expenses, like repairs to the rented room, are fully deductible. Shared expenses, such as utilities or mortgage interest, are allocated based on the rental area percentage.

For example, if 10% of your home is rented, 10% of shared expenses can be deducted. This allocation must be documented thoroughly. Rental income and expenses are reported on IRS Form 1040, Schedule E, and supporting records are essential.

The Tax Cuts and Jobs Act of 2017 introduced limits on deductions, including a $750,000 cap on mortgage interest and a $10,000 cap on property and state taxes. These changes require careful planning to optimize deductions.

Depreciation Considerations

Depreciation enables homeowners to recover the cost of wear and tear on the rental portion of the property. The IRS requires residential rental property depreciation to be calculated using the Modified Accelerated Cost Recovery System (MACRS) over 27.5 years.

To calculate depreciation, determine the property’s basis, typically the purchase price plus capital improvements, minus the land value. Land is not depreciable, so its value must be separated from the structure. Apply the rental area percentage to the adjusted basis to find the depreciable amount. For instance, if the depreciable basis is $150,000 and 10% of the home is rented, $15,000 is the depreciable basis.

Depreciation must be adjusted for partial-year usage if the room wasn’t rented for the entire year. Upon selling the property or ending the rental arrangement, depreciation recapture rules apply. The IRS requires previously claimed depreciation to be reported as income, which may result in additional tax liability, capped at 25%.

Reporting Rental Income

All rental-related earnings, including rent payments and fees for utilities or cleaning services, must be reported on Schedule E of Form 1040. Security deposits are not considered income unless used to cover unpaid rent or repair costs.

Maintaining accurate records of transactions is essential. Receipts, invoices, and tenant agreements should be retained to substantiate income and deductions. These documents provide critical evidence in case of disputes or audits.

Record-Keeping Requirements

Thorough record-keeping is vital for compliance with IRS rules and audit protection. Taxpayers must retain documentation supporting all income, expenses, and depreciation claims for at least three years from the tax return filing date or two years from the date the tax was paid, whichever is later.

Organizing records by category—such as rental income, direct expenses, shared expenses, and depreciation schedules—simplifies the process. A ledger of rent payments and copies of lease agreements substantiate income, while receipts for repairs and utility bills support deductions. For depreciation, documentation of the property’s purchase price, land valuation, and capital improvements is necessary.

Written agreements with tenants, including those outlining shared utility costs or responsibilities for repairs, can clarify expense allocations. A log of shared space usage, such as a calendar tracking tenant access to common areas, can further support claims. Digital tools like accounting software or cloud-based platforms help streamline record management and ensure backups are available. By maintaining organized and accurate records, homeowners can confidently address the tax complexities of renting out part of their home.