House Hacking - how do the rental taxes work?

Question

I am 29 and looking to purchase my 1st home soon that I plan to house hack. I live just outside of DC and this is the only affordable way to buy a house in such an expensive area. I’m having a difficult time finding how rental taxes work while I’m living in the house. Will the rental income be taxed as regular income? Are their methods for reducing these taxes?

I would love to hear any thoughts / tips / wisdom!

Thank you!

Cam

I would love to hear any thoughts / tips / wisdom! Thank you!

Cam

Basit Siddiqi · Answer

@Cameron Seider

House hacking makes your tax situation more complex.You purchased a property that is treated as both an investment property and a personal residence. As such, payments that you make need to be prorated between business deductions and personal deductions. Payments that you make normally fall into one of 3 buckets100% of the payment can be factored in somewhere on the returnPartial payment can be factored somewhere on the return0% of the payment can be factored in somewhere on the returnHouse-hacking also has considerable tax implications in the event that you want to sell this property.

You can potentially defer a portion or all of the gain on the investment property with 1031 exclusion.You can potentially exclude a portion or all of the gain on the personal residence with section 121 exclusion

Natalie Kolodij · Answer

For depreciation you can only depreciation 100% rental space.

In your example the renters 150 sq feet can be depreciated- if they also have their own bathroom that can be depreciated as well.

So 15% of your building value gets deprecaited.

For your overall bills- mortgage interest, utilities, property taxes ect- you can allocated based on a shared use area too.

so 15% = business use + 50% of the  700 shared spaces as business use

And that combined amount will be used for the operating expenses.

Mason Kimball · Answer

Hi Cam,

Here is an awesome BP article on the tax considerations of house hacking: https://www.biggerpockets.com/...

Let me know if you have any additional specific questions and best of luck with your first house hack!

Mason

Cameron Seider · Answer

Thank you Natalie, very clear. Makes complete sense!

As my taxes become more complicated, would it make more sense to have an accountant during tax season? I’ve always done my own taxes on turbo tax and like the idea of continuing to do them myself, but I recognize that I could potentially use an expert’s help.

Mason Kimball · Answer

So if you’re doing a by the room house hack, you would only be able to depreciate the area that is exclusively occupied by the tenant. So that does not including common areas.

Also, don’t forget to separate the value of the building from the value of the land, you cannot depreciate land. You can do this by using the replacement cost of the building from your insurance appraisal

Let me know if you have any other questions!

Mason Kimball · Answer

Yes that is correct, you would be taxed at whatever your marginal rate is. Don’t forget to take all deductions you qualify for though. If you look at Form 1040 Schedule E, you’ll see examples of some expenses that are deductible at arriving at your net rental income/(loss)

Cameron Seider · Answer

Thank you for the great information Basit.

I plan to hold the house long term after I move out treating it as an investment rental home. After which I would consider either a 1031 exchange or much less likely moving back in for 2 years prior to selling it to reduce the capital gains taxes (although not sure if this would also take care of the tax deferred depreciation?).

Cameron Seider · Answer

Good luck to you as well!

Mason Kimball · Answer

No problem!

I am on a similar path as yourself in trying to find my first house hack except I am looking for a duplex not renting by the room.

Best of luck!

Cameron Seider · Answer

Mason, thank you for all your help! This was extremely informative. I can approach buying my first property with a little more confidence now.

House Hacking - how do the rental taxes work?

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