How to apportion costs of rehab when renting out rooms in home

Question

I wanted to see if there were any tax experts who have ever rented rooms out in their home. The answer my enrolled agent who is not a real estate expert gave me did not seem to make logical sense to me and I wanted to get some advice here.

My business partner and I rent out 4 bedrooms in our six bedroom home. One of the three bathrooms is for exclusive use of tenants.  The rooms we live in are smaller and on the third floor. Second floor is rented to tenants and first floor has kitchen, a bathroom, giant living room and dinning room.

How do we go about picking the % of the building to depreciate?

My tax person said that the work we did to the common area's of the building is considered personal expense and is not tax deductible (or dep).  Would this be true?  How about repairs to the roof and overhangs?

We are renting this place with utilities included.  Now I have seen some logic that the water and sewer bill can be expended 2/3. Can heat only be expended at the same % of building that is depreciated? How about electric? Would this be closer to 2/3 since there are more renters in the building using more power?

I would love to hear from someone who has done this before.

We are located in Mass if that is of interest to anyone.

Donald Hendricks · Answer

Way too much effort being expended here.

Brian McCarter · Answer

So I did all the work to calculate the square footage of each room. By allocating the common areas by the number of people method(4/6), and excluding hallways and stairs as allowed, setting tenant rooms as 100% and landlord bedrooms at 0%: I get a business use figure of 68.5%.

Would it be reasonable to write off all expenses at 68.5% or should I break them apart? (building wide systems 68.5%, common area costs 66%, heat and electric 68.5%, Water 66%, tenant room repairs/ legal/credit check costs 100%, landlord room repairs 0%)

Joe Craft · Answer

I also prefer the square footage method over the number of rooms method.  I see no problem with having a different method for the common area repair and maintenance and the utilities for the entire building.  What is important is that you pick a reasonable method and be consistent. For the common areas, I , the number of people is a reasonable method.  I would figure it several ways, choose the method that yields the highest deduction and then stick with that.

Steven Hamilton II · Answer

Brian McCarter,

Common areas can be depreciated and deducted.  It is highly recommend you do so. You however, cannot depreciate the entire area, you must do it by the business percentage.

-Steven

Brian McCarter · Answer

It may be that I have not articulated my question clearly or am looking for a far more nuanced answer, but there are still a few issues that I see. It would seem that the dividing of expenses by a live in landlord does not have much coverage in tax literature due to its rarity compared to investors with multi family homes.

Repairs and improvements to our personal use only rooms are our own expense. Check.

Expenses or improvements to shell of building or building wide systems are at the same % as depreciation. Check.

What about areas that are use by both tenants and landlord (kitchen, first floor bathroom, dinning room, living room)?

Why must ALL expenses be apportioned evenly ? IRS website http://www.irs.gov/publications/p17/ch09.html in the how to divide expenses section says that " It may be reasonable to divide the cost of some items (for example, water) based on the number of people using them." This would seem to indicate that it is possible to apportion them in different ratios.

What other "reasonable methods" have been found to hold up in tax court? The IRS only refers to the two most common ones "The two most common methods for dividing an expense are based on (1) the number of rooms in your home, and (2) the square footage of your home. "

My enrolled agent pulled out a book when I last visited that said when renting rooms in your home, repairs and improvements to the common areas of the home, are not depreciated or expenses.  This would lead me to believe that just using a % of all expenses may not be considered reasonable. Did this tax book even correctly interpret the tax code?

Steven Hamilton II · Answer

Brian McCarter,

You will want to apportion the parts of the home evenly.  Now if you remodel part of your bathroom, that will not be depreciated or expensed.

You will deduct expenses based upon the usage of the property.  So if you and your business partner utilize 1/3 of the home. The remaining 2/3 of each expense is taken and 2/3 of the total cost is depreciated.

I'm not fond of the by number of rooms method as it does not always give an accurate depicture.  I prefer the square footage method.

Back to tax returns.....

-Steven

Ann Bellamy · Answer

Not sure if the # of rooms method is supportable, maybe Steven Hamilton II can chime in.

Sorry about reaching out to Joe, it's that very difficult time of year to connect with a tax accountant.  Easier in the off season.  I've sent him an email about you.

Brian McCarter · Answer

My main issue is trying to determine how much of the property is used by the tenant for IRS purposes.

I actually reached out to Joe Craft a few weeks ago to find out what his services would cost, but had not heard back. My business partner and I have been doing everything in our power to keep everything digital so location would not bother me.

After study the tax code, it seems the issue I am having is what the IRS considers the various "reasonable method's" of dividing the expenses.

Logically I would say that if four of the six bedrooms are rented, everything is split 2/3 towards rental expense. This would give credit for the use of the common area (living room, dinning room, kitchen and one of the three bathrooms).  However is this justifiable?

Using the number of rooms method it would be closer to 5/12 (four bedrooms and a bathroom).

I have not calculated SF method but it's likely to be between 30% and 40%

Ann Bellamy · Answer

I believe my accountant would not agree with your accountant, but the "common area" thing is a little different from living in a duplex and renting half.

Essentially, my accountant said to calculate out the percentage of SF used by the tenant, and then all expenses get apportioned by that same percentage, including depreciation.

So for example 2/3 of your property taxes would go under that property on Schedule E, and 1/3 (your part) would go on your schedule A for itemized deductions.

However, this is a case where an accountant makes you more than you pay him.  Get a good accountant who has significant clients who are real estate investors and/or small business people.

My accountant is no longer local to me, but he used to be in NH and travels regularly to NH and MA.  He's very good with small business and with real estate investing.   We do almost all communication electronically and by phone, so it doesn't matter that he doesn't live here.

www.joecraftcpa.com  if you are looking for a referral  Moderator - no affiliation other than he is my accountant and most of my partners use him also.  We've had him speak at Black Diamond.