Living in the beautiful Smoky Mountains where there are a lot of tourists and demand for nice accommodations, you may want to rent your spare room to earn a little extra money. Is that a good idea? The answer is the same as that for most tax questions, “it depends”.
As long as the room is rented more than 14 days per year, the income you receive must be reported on your tax return as rental income. If not, the income does not have to be reported. However, if you report income, you are also allowed to deduct any ordinary and necessary expenses that you spend specifically for that room. Examples are furnishings, advertising, hiring someone to clean after someone leaves, etc. You may also deduct a portion, based on square footage, of any general expenses that pertain to the whole house, such as real estate taxes, mortgage interest, and hazard insurance.
Another deduction allowed is depreciation. You may write off a portion of the house as long as it is used exclusively as a rental. The spare bedroom can be depreciated. Common areas such as a kitchen or family room cannot.
So far this seems pretty good. You can write off a lot of your expenses against the rent you receive. The problem comes when you sell the house. When computing the gain from the sale, you have to split the house into two portions. First, the personal part, which may not be taxable, and the rental portion will report some gains. Depreciation, whether you take it or not, must be added back and taxed at regular rates. Any additional gain must be reported although it may be taxed at lower capital gains rates. Since real estate prices keep rising, renting your room out may not be as good of an idea as was originally thought.
So carefully think it all through when you are considering renting that extra room. It may not be as good as you think. Or better yet, consult a tax professional who can prepare a projection comprised of different scenarios and outcomes. It is good to know what you will be facing when you sell the property.
The above information is provided for general educational purposes only and may not reflect changes in tax laws. Before taking any action based on this information, consult with your tax advisor about your specific situation.