This post originally appeared on Trulia.
In today’s sharing economy, it’s appealing to make every inch of space work for you whether you rent or own. That extra bedroom that felt like a good idea at the time? Admit it: Now it’s a graveyard for unused exercise equipment.
Assuming that you find the right tenant — and that you secure any required licenses or permissions from your landlord or homeowners association — subletting can help defray extra costs and pile up a little bit of cash on the side.
Of course, this assumes that you’re actually subletting. The rules are different if you are merely splitting a lease. If you share an apartment, rental payments aren’t made to you (they’re ultimately made to the landlord, right?), so they’re not included in your tax burden.
Subletting is a different story. So before Uncle Sam dips his hand into your pocket, it’s worth it to familiarize yourself with the financial intricacies of subletting or renting out a room.
Do I have to report all rents paid to me, even if it’s just for one room?
As a rule, the money you receive is usually taxable as rental income — whether you’re renting out a mansion in Beverly Hills or the spare room in your walk-up apartment.
You’ll need to report the total rent paid before you offset for any expenses or deductions (more on those later). You’ll also want to report any extras, including advance rents and cancellation fees.
Include security deposits only to the extent that you keep them; if you return the deposit to the renter, park it in an escrow account to refund later, or only require the deposit in the case of damage, don’t count that as income. Laws governing security deposits are generally state and local specific, so be sure to check those out ahead of time.
Do I report rents paid to me when I receive them or when they’re due?
For tax purposes, you’ll report rents when you receive them. If you are paid in advance, it’s taxable in the year you have payment in hand — even if some of the payments will be applied to the next year. Likewise, a promise to pay or a lag in payment is taxable when actually received, not when demanded or expected.
What about deductions?
Deductions work the same way. For expenses related to renting, you’ll claim deductions in the same year that those expenses are paid. Prepaid expenses — a yearly service contract for example — are deductible in the year paid and not in the year that the work is performed.
So what can I deduct?
You can take a deduction for expenses related to your rental. Those include utilities, services like garbage or snow removal, security, Internet or cable service, and heat (to the extent those aren’t paid by the tenant). Maintenance and repairs to the rented space also qualify — but not if the upgrade impacts your entire living space.
You can’t, for example, deduct the cost of painting your entire apartment. But if you can calculate the cost of painting the room you’re subletting and a percentage of common spaces, that’s likely deductible.
Use care when deciding what’s a necessary maintenance expense or repair: you can’t deduct the cost of improving your space for short-term rentals.
What if I don’t get paid?
Since you can deduct only actual expenses and losses, if your prospective tenant says she’ll pay you and she doesn’t, you’re out of luck on the tax side.
Uncollected rents are considered tax neutral. You can’t claim them as income or as a deduction. You can, however, deduct related costs to mitigate your damages, such as advertising for a new tenant or going to court to get paid.
Is there any way around reporting these rents as income?
There is — and it’s a big one. If you rent out your space for fewer than 15 days in the year, you don’t report rents paid to you (and you can’t deduct the related expenses either).
Keep in mind, those 15 days are the yearly total for the space, not per month or per tenant. The provision is meant to apply to a super-short-term rental or sublet (such as when you’re on vacation or going home from school).
Anything else I need to know?
Actually, there’s a lot. But here’s a quick look at some answers to common questions.
- Remember to check with your landlord, homeowners association, or other applicable authority before signing a contract with anyone to move in.
- Speaking of contracts, it’s always a good idea to have a lawyer look at your rental or sublet contract before signing.
- Having strangers in your home can be profitable — but it also can be scary. Do your due diligence when selecting prospective tenants.
- Pay attention to state and local rules regarding permits, licenses, and taxes.
- Always check with a tax or real estate professional if you have questions.