Tax Implications of Renting Your Primary Residence

The cost of homeownership is rising, but many homeowners are offsetting the increasing costs by renting parts of the home. Renting your home is a great way to earn extra money from your most valuable asset, but you should consider the tax implications of renting your primary residence before you open for business.

Sharing Your Home on Airbnb

Platforms like Airbnb have made it easier than ever to rent out your property, so it’s no surprise many homeowners are opening their spare bedrooms up to travelers and other house guests.

Renting out your home offers obvious financial benefits, including the potential to generate steady income from your properties every month. Landlords are also privy to additional tax benefits not typically available to homeowners.

If you’re considering using your primary residence as a rental property through platforms like Airbnb, you have two main options: short-term or long-term rentals.

Short-term rentals, typically lasting 28 days or less, provide the flexibility to swiftly handle unsuitable tenants. In contrast, long-term rentals offer the advantage of consistent income and fewer concerns about vacancies.

You should consider the tax implications for short-term and long-term rentals carefully before deciding which you will allow. Also, reference your state laws to learn more about legal protections for long-term tenants.

Some states are significantly advantageous to the tenant, so you could get stuck with an unpaid guest for months if something goes wrong. Make sure you know what you’re getting yourself into.

Tax Implications of Renting Out Part of Your Home

Before you rent out your home through Airbnb or a similar service, consider the many tax implications of doing so, which include everything from possible homeowner deductions to local rental regulations. 

Homeowner Deductions

As a homeowner, there are many potential tax deductions you can claim, which include mortgage interest, property taxes, and certain rental-related expenses.

While some of these deductions are available to homeowners regardless of whether they rent out their home, others are specific to renters.

Some examples of deductible expenses associated with renting part of your primary residence include:

  • Advertisements
  • Taxes
  • Utilities
  • Supplies
  • Repairs
  • Management fees
  • Mortgage interest
  • Insurance policies, which include landlord liability and homeowners insurance
  • Maintenance and cleaning

Let’s say that your rental property earns you around $20,000 in gross rental income each year. If the amount of money you pay for the expenses listed above equals $15,000, your taxable net income for the year would be $6,000. 

Depreciation Considerations

When you transform your primary residence into a rental unit, it’s crucial to consider depreciation.

This process allows you to account for the property’s physical deterioration over time. Typically, residential rental properties are depreciated over a 27.5-year period.

To leverage this depreciation expense, start by determining the property’s cost basis at the time of conversion to a rental.

This basis includes the original purchase price, closing costs, and any capital improvements made to the property. It’s important to note that land cannot be depreciated, only the building itself.

For example, if your property is valued at $325,000, and the land is worth $40,000, the depreciable value would be $285,000 (property value minus land value).

To calculate the annual depreciation expense, divide this amount by 27.5 years. In this case, it would be approximately $10,363 per year.

Claiming depreciation deductions annually can effectively reduce your taxable income from the rental property and increase your overall tax savings.

Local Laws and Tax Regulations

Before you rent your primary residence, take a minute to checks state and local regulations. Some landlord-tenant laws forbid partial rentals of homes, and some jurisdictions require special permits.

Check local tax officials to determine your options. If you live in a neighborhood with an HOA or tenants associations, you should check with them too.

Ensure your business is legal and complies with local regulations before you host your first renter. Otherwise, costly consequences could blindside you down the road.

schedule e vs c

Reporting Your Rental Income

Renting your primary residence comes with additional tax obligations. Perhaps the most important is accurately reporting your income.

IRS regulations require you to report your rental income and expenses using Schedule E on Form 1040. Individuals typically use Schedule E to report income from a passive business activity, like renting part of your residence.

Make sure you accurately list your expenses, depreciation, and income for every rental property you own. 

For example, deducting expenses for someone who’s partially renting your home is only possible if you split expenses between the portion of your home that’s rented and the portion that you live in. 

Some examples of expenses that you have to allocate include real estate taxes, mortgage interest, and mortgage insurance premiums.

You can also deduct qualified home improvement projects, in some cases, if you’re operating a rental out of your home.

If you own rental properties under an LLC that lists you as the sole owner, you’ll need to use Schedule C instead of Schedule E.

Schedule C is used to report income from active business activity, and it allows you more flexibility with claiming deductions.

Whether your income falls under Schedule C or Schedule E, make sure you report it accurately. IRS regulations require you to report any rental income exceeding $600, so even small amounts of income must be reported.

The Capital Gains Tax Exclusion

When you sell your home and earn profit from it, you’ll be tasked with paying taxes on these profits, which are considered capital gains taxes. However, you can claim a capital gains tax exclusion if you lived in your home for more than two of the five years prior to the sale.

If you file a single return, you don’t need to pay capital gains taxes on up to $250,000 in profits. When filing jointly, the exclusion limit increases to $500,000.

Even if you rented the home for three years, you can claim this exclusion as long as you resided there for the other two years. The exclusion also applies when you rent a portion of your home.

Is Renting Your Primary Residence Right for You?

There are many advantages associated with renting out your main residence. However, there are also several risks and drawbacks that must be considered. The challenges associated with renting out your home property management and compliance, plus, dealing with guests.

However, you’ll receive passive income in exchange for your troubles. You could also rent out the entire property and go take up a temporary residence somewhere else. In addition, you may qualify for some valuable tax relief.

Closing Thoughts

When you rent out your home, you should first consider the tax implications of acting as a landlord. As long as you don’t permanently rent out the property, you can take advantage of the capital gains tax exclusion if you sell it in the future.

Shared Economy Tax is the leading tax firm for Airbnb pros and real estate investors. Our veteran tax pros know the industry inside out, and we can help you rack up huge tax savings with cutting-edge strategies customized for your business. Get started now with a one-on-one strategy session with one of our tax pros.

About the Author

Miguel Alexander Centeno

Miguel Alexander Centeno is an author, speaker, and tax leader at Shared Economy Tax. A former Big 4 tax manager, he represents taxpayers in all matters before the IRS, including the U.S. Tax Court. He has been quoted in the Wall Street Journal, Fox Business, and MSNBC on tax related articles and has testified before the U.S. House of Representatives as a part of hearings for the Tax Cuts and Jobs Act. A father of three, Miguel is an avid acoustic guitar player, gravel cyclist and once-a-week yogi.
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