#MIDDLEBURY
by Mark A. Burns
In last month’s column, we discussed some of the basic issues related to turning your personal residence into a rental property. This month we will cover some more advanced issues related to this subject.
Renting part of your home – What happens if you rent out part of your home, but not the full home, e.g., perhaps a second-floor apartment? In this case, the rules are very similar to renting the full house. The income must be reported in full and, generally speaking, the same types of expenses discussed last month can be written off against the income.
If certain expenses relate fully to the rental portion of the house, then they can be fully written off. But those expenses that relate to the entire house must be allocated to the rental portion of the house based on square footage or some other reasonable method. In this partial rental scenario, there may be other limitations on which expenses can be deducted in a net loss situation.
Selling your home that has been rented out – What happens when you sell your home after it has been rented out? Do you need to pay taxes on any capital gains? As discussed last year in this column, when a home has been owned and used as a personal residence for at least two of the last five years, then any capital gain up to $500,000 (if married) or $250,000 (if single) is generally tax free.
If part or all of the home has been a rental property, but you still satisfy the two-out-of-five-year rule, then the same tax-free rule applies, with the exception that to the extent the gain is attributable to depreciation allowed as a rental property, then that portion of the gain is taxable income. (As a side comment, that depreciation “recapture” rule also applies if you have been taking depreciation on your home related to an office-in-the-home tax deduction).
As mentioned last month, the IRS defines a rental property as a “passive activity” and thus some of the rental losses may be disallowed in the current year (based on income levels on your tax return). These “suspended” passive losses are carried over to future years and eventually allowed when one of these three events occurs: your income drops below the indicated level, you have rental or other passive income in the future to absorb the losses, or you sell the property.
The above discussion relates to rental of a home that has been fully or partially a personal residence. If the rental property is a separate structure from the personal residence, different rules apply. Different rules also apply to a second, or vacation, home.
The above is a very general summary of what can be a very complicated subject. Each person’s particular situation can be unique. Always consult a tax professional if you are uncertain about how tax matters might affect you.
Mark A. Burns, M.B.A., is a C.P.A. with Diversified Financial Solutions PC in Southbury. He can be reached at 203-264-3131 or Mark@DFSPC.biz.
