Making Cents: Temporary renting of your personal real estate has many possible risks
By: John P. Napolitano, CFP®, CPA, PFS, MST, RLP®
Whether you call it home or room sharing, short term rental arrangements or whatever the regulatory bodies ultimately call the service, millions of people worldwide have jumped on the bandwagon of either renting or advertising rooms for rent for as short as a single night. This may work wonders for your cash flow if you need extra money, but it also has a set of income tax and risk management considerations that cannot be ignored.
For tax purposes, as soon as you make your home available and start to advertise it, you are technically converting all or part of it to rental property for tax purposes. What that means is that you’ll have an accounting exercise each year to segregate your expenses to separate those costs incurred towards the rental activity versus those that were for your personal portion of the property.
If you paint the rental area, it may be a legitimate expense against your rental income. But if you paint the entire home, only the pro rata share of the paint job that applies to the rental area will be deductible against your rental income. This same type of allocation must be made for all of the homes expenses, whether it is your mortgage interest, property taxes or water and utility bills.
You’ll also get to depreciate a portion of the home. This may feel good as your reporting rental income, but then when you go to sell the home, the depreciation deduction will reduce your basis and possibly cause a part of your gain to be taxable.
Beyond the income tax consequences, there are risk management considerations that may impact your decision about entering this rapidly growing market. Your primary residence insurance policy may not have protection against your using the property as rental property. Furthermore, what type of rental property are you? Are you traditional, hotel or bed and breakfast type of landlord?
Because of the short term stays and frequent turnovers common in this online marketplace, most risk professionals would place you in the bed and breakfast category for insurance purposes. That means a rental rider or even a traditional rental property type of coverage may not be adequate in the event of a large claim.
The cost for this policy upgrade will vary depending on the type of property and the location. Not upgrading your policy because of cost is negligent and should be avoided. If you feel that the cost is too high and that your rental income will not justify this extra cost, then you probably shouldn’t rent the room or home.
On the other hand, if you do go ahead and upgrade your policy, consider asking a risk professional to walk the property with you and do a risk assessment. In this assessment, you are looking for things about the property that may be a risk catalyst. A jet ski, for example, with a sign that says “use it any time” could be considered an attractive nuisance that costs you dearly if your temporary tenant uses it and causes a problem.
John P. Napolitano CFP®, CPA is CEO of U. S. Wealth Management in Braintree, MA. Visit JohnPNapolitano on LinkedIn or uswealthnapolitano.com. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor. John Napolitano is a registered principal with and securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through US Financial Advisors, a Registered Investment Advisor. US Financial Advisors and US Wealth Management are separate entities from LPL Financial. He can be reached at 781-849-9200.