How to best handle boarder income?

Question

Hi, I rented the rooms out in my basement this past year and collected $16,200 in income. How can I best handle this income, come tax time? It's obviously a good chunk of money that will be added to my income but have read that I can deduct certain expenses in order to reduce the income. Does claiming the income have any benefit other than it obviously being legal? Can I establish an LLC at this point even if it is my primary residence and I am the owner? Can my new wife, who isn't on the title yet, claim the income separately? How much is boarder income taxed and how is it treated? What happens when the income - expenses equals in the negative?  Also,   I have been reading on BP that lenders do not count boarder income in order to qualify me for a loan. Am I safe to assume that in the next year, which is when I would like to buy an investment property, it will not be used as additional income in order to reduce my DTI and qualify for a better loan? Thanks.

Linda Weygant · Answer

@Christopher Nerio - you've got a small mess here, but it's being compounded by the information you've received so far from others on this post.

First of all, the boarder income is still traditional rental income - that is, passive income.  @Scott Vance has gone down a bit of a rabbit hole with his advice on that.  If you are just providing space for rent, then it is traditional rental income.  The business income comes into play if you are providing more of a Bed & Breakfast or Executive Rental concept where there are significant additional services provided such as maid service, meals, etc.

You've also got Account Closed providing some advice that is a bit off base (Splitting the title with yourself???  What does that even mean?)

Here's the deal:

No, you cannot run this through an LLC since this is your primary residence.  An LLC has no bearing from a tax standpoint - it is simply a liability/exposure tool.  But since this is your primary residence, there is literally no way to separate out the business aspect of the building from the personal aspect and an LLC wouldn't work here.

What you do is you claim all the rental income on Schedule E.  You then apportion your other building expenses and report those on the Schedule E as well.

Here are the expenses you'll want to consider:

Mortgage Interest

Property Tax

Insurance

Water/Gas/Electric/Sewer/Garbage Removal/Lawn Maintenance/Pool Maintenance (presuming your tenant is allowed to use the lawn and pool)

Repairs to the property as a whole (ie, roof, plumbing, electrical repairs)

Repairs specifically to the space you are renting

Depreciation

You then measure the room you've rented and compare it to the livable square footage of the house.

So let's say you're renting a 300 square foot space, your bedroom is 500 square feet and you share the kitchen, bathroom and living areas and those common areas add up to 1000 square feet.

So your rented space is 300 + (1000/2) for an effective square footage of 800 square feet rented.

You then take the above mentioned expenses and multiply each one by (800/1800) and you claim that amount of expense.

The only exception is repairs specifically to the rented area.  For example, if you paint the are you're renting out, and only that area, then the expense to do that is written off at 100%.

Linda Weygant · Answer

Yep, you've got it correct.  Depreciation is calculated the same way as everything else.  Figure what it would be for the whole building, then take .45 of that.  In order to figure out the basis for depreciation, you take your original purchase price, plus some of the closing costs (not all of them qualify) plus significant improvements made (new roof?  new garage?) and add them all up to get your total purchase basis.  You then have to allocate some of this to land.  You can get a good feel for land vs building percentages by looking at your property tax assessment.  Here is Colorado, I use a ballpark of 20% to allocate to land.  (Land is not depreciable).  The remaining 80% is depreciated over 27.5 years and, in your example, you'd take .45 of whatever that number ends up being.

Dave Toelkes · Answer

@Christopher Nerio,

When you convert your property to a rental, the tax basis for depreciation is either the adjusted cost basis (calculated the way you described), or, the market value at the time of conversion, whichever is less.

If the FMV was less than your calculated cost basis, then that number is used to determine your depreciation expense in the manner you described.

Dave Toelkes · Answer

@Christopher Nerio,

Typically, a homes square footage does not include basement space.  If your home is 2100 sq ft without the basement, then with the basement, your total square footage would be 3050, making your rental portion 31%.

Christopher Nerio · Answer

Hey @Linda Weygant thanks for awesome advice. Just to make sure I understand. My house is about 2100 sq. feet. It is a split level home. I rent out the entire basement which is about 950 sq.ft. With that said would I claim 950/2100 which is .45 correct? So that would be 45% of MI, Property Tax, Insurance, Utilities, repairs, etc.  If you don't mind me asking how is depreciation calculated? I have owned the home for 22 months. Thanks again.

Christopher Nerio · Answer

Hi @Scott Vance and Account Closed thanks for your help. Hopefully, since my wife was working towards her bachelors degree, she didn't work much so I wonder if her minimal income may help us when we file.

Account Closed · Answer

@Linda Weygant, I meant that, at least here in WA, one way to create bullet proof liability protection is to segregate or split the rented space as an address / title and transfer that new titled real estate to the LLC.

Account Closed · Answer

@Christopher Nerio, If the LLC owns the house as a business and you also live there, then you are a tenant as well. For the downstairs suite to be a tenant of the LLC you might need to split the title with yourself. I agree with @Scott Vance that the LLC is about liability but not helpful at tax time. However, for a house in which you live, if there are issues, I believe hiding behind State liability laws is not likely to work.Your best advisor on the tax points is the accountant / CPA who signs your tax returns. For the LLC legal issues see a Virginia attorney as these liability issues vary slightly state by state.

Scott Vance · Answer

@Christopher Nerio  You will need to file taxes as a business.  The income I think based on what you have told me will be taxed as income.  The good thing is you can reduce that income by your costs for running the business of having boarders.  Establishing an LLC has nothing to do with taxes it has to do with protecting you in case you are sued.  Whether you or your wife claim the income doesn't really matter, I assume you are going to file Married filing jointly so both incomes are combined.  If you filed Married but seperate you would be hit with alot of taxes that probably would make it very detrimental from a tax standpoint.  I am pretty sure, based on what you have written that the "Boarder" income will be treated and taxed "income" as opposed to a traditional rental where you rent a house to a person is treated as "Passive Income".  Regarding the income from the boarder, my experience with that is most lenders require 2-3 years of tax returns showing that income to be considered into the DTI ratio.  Each lender is different.  Make sure you find and speak with an Enrolled Agent or CPA to make sure you are not breaking any IRS rules.

How to best handle boarder income?

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