What Are the Tax Implications of Renting Out My Room?

Published August 30, 2024.
Written by Gisele Afman.

The Tax Implications of Renting Out a Room in Your Home

Renting out a room in your home can be a great way to generate extra income, especially in the competitive this real estate market. However, it’s essential to understand the tax implications to make informed decisions. Below, we’ll break down the key points to consider when renting out a room in your home.

1. Claiming the Room as a Rental

When you rent out a room, you have the option to claim it as a rental property on your taxes. This means you’re converting a portion of your home into a rental business, which has significant tax implications.

• Depreciation: You can depreciate the part of your home used for rental purposes. For example, if you rent out one-fourth of your home, you can depreciate that portion. Depreciation lowers the value of that part of your home for tax purposes, but it also increases your capital gains tax when you sell.

• Taxable Gain: When you eventually sell your home, the portion that was rented out will be subject to capital gains tax. This is because you claimed depreciation, which decreases the value of that section of your home and, therefore, increases the taxable gain upon sale.

2. Writing Off Expenses

One of the benefits of renting out a room is that you can write off certain expenses related to that portion of your home. These expenses might include:

• Maintenance and Repairs: Any costs associated with maintaining or repairing the rented room can be deducted.

• Utilities and Insurance: You can also deduct a portion of your utilities and home insurance.

• Mortgage Interest and Property Taxes: A percentage of your mortgage interest and property taxes can be deducted based on the portion of your home that is rented out.

These deductions can reduce your overall taxable income, but they also require meticulous record-keeping to ensure accuracy.

3. Reporting Rental Income

Any income generated from renting out a room must be reported on your tax return. This income is typically added to your total taxable income and taxed at your regular income tax rate. However, the deductions mentioned earlier can help offset this additional income.

• Compliance Risks: Some homeowners might choose not to report this income, but this poses significant risks. If you’re audited or if a disgruntled tenant reports you, you could face penalties and back taxes. It’s always safer to report the income and take advantage of the allowable deductions.

4. Impact on Capital Gains Exclusion

When you sell your primary residence, you can typically exclude up to $250,000 ($500,000 for married couples) of capital gains from your taxable income. However, renting out a portion of your home complicates this exclusion.

• Reduced Exclusion: The portion of your home that was used as a rental property may not qualify for the full capital gains exclusion, which could result in a larger tax bill when you sell your home. It’s crucial to understand how this exclusion will be affected based on how long you rented out the room and how much of your home was used for rental purposes.

Finally: Make Informed Decisions

Renting out a room in your home can be a smart financial move, but it’s essential to understand the tax implications. By claiming the room as a rental, you open yourself up to both opportunities for deductions and risks associated with capital gains taxes. Always consult with a tax professional to ensure you’re making the best decisions based on your specific circumstances.

For real estate investors, first-time homebuyers, or anyone navigating the Southern California market, understanding these nuances can help you maximize your investment while staying compliant with tax laws. If you’re considering renting out a room, don’t hesitate to reach out to a local real estate agent for more personalized advice.

By keeping these factors in mind, you can make the most of your rental income while minimizing potential tax burdens.

For more information on real estate opportunities in these areas, feel free to contact the Marty Rodriguez Team. We’ve been helping our clients make the right decisions about real estate in Southern California since 1978!