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Is Having a Roommate a Tax Shelter?
Home-owners Bill and Jane have an extra bedroom in their single family residence. They decide to rent it to Sammy the student for $300 per month. It’s a good deal for Sammy, because the rent he pays covers his share of the utilities, too. AND… he shares the kitchen, bathroom, and living room.
When tax time rolls around, Bill says to Jane, “This has been great. Not only have we helped off-set our mortgage payments, but we can save even more on taxes by depreciating Sammy’s bedroom and a portion of the common areas, as well as write off his share of the utilities!”
Jane looks puzzled. “Bill,” she says, “have you been sipping that ol’ home brew again?” But as she will learn when they visit their tax advisor together, Bill is right.
If you’re renting out a room in your primary residence, you’re a landlord, and you’re therefore entitled to some of the tax-sheltering benefits of real estate. Like any investment property, it takes careful record keeping and some basic calculations to figure out what you’re entitled to, but it’s not rocket science. Let’s review the basics here:
1) Whether you have a roommate or not, you’re allowed to write off the mortgage interest and property tax on your home as an itemized deduction.
2) Residential investment real estate is depreciated (now known as “cost recovery”) over 27.5 years. Remember, only the improvement (the house itself, not the land) qualifies for depreciation, so use your tax assessment, appraisal from when you purchased the house, or home owner’s insurance policy to determine the ratio of improvement value to land value. In this case, let’s say Bill and Jane’s house accounts for 75% of the total value of $200,000… or $150,000. $150,000 divided by 27.5 (years) = $5455.00 per year.
3) Since only a portion of the house is rented, though, Bill and Jane can only depreciate that portion of the $5455.00. The way they figure it is to consider the size of Sammy’s rented room, plus 1/3 (since he’s one of three people living in the home) of the common areas — the kitchen, bathroom and living room. The house is 1000 square feet total. Sammy’s room is 150 square feet, or 15%, and the common areas are another 750 square feet. One third of 750 is 250, or another 25%. So 15% + 25% = 40%. $5455 x 40% = $2182.00.
4) For the purposes of this exercise, we’ll assume Sammy has lived at the house all year, and that it’s his 2nd year there (so we don’t have to bother with mid-month convention (??? — call me, I’ll explain it). So Bill and Jane are going to subtract that full $2182.00 off their annual income, and since they’re in the 25% tax bracket, that means an extra $545.50 in their pocket that didn’t have to go to Uncle Sam.
5) Yes, they also get to write off the 40% portion of their utilities that Sammy’s using, since utilities are a “rental expense.” AND… they may end up depreciating an appropriate portion of certain appliances and furnishings over a 5 year period, rather than 27.5 years.
TALK TO YOUR TAX ADVISOR! This is JUST an introduction to this concept, and there are all sorts of issues to be discussed with YOUR TAX ADVISOR. The rent you’re collecting is taxable income. There are different methods and schedules of depreciation. Then there is cost recovery “recapture” when you sell. Again, TALK TO YOUR TAX ADVISOR to get a full understanding of this concept.
