Making Cents: Temporary Renting of Your Personal Real Estate Has Many Possible Risks
By: John P. Napolitano, CFP®, CPA, PFS, MST
Whether it’s called home or room sharing, short term rental arrangements (or whatever the regulators ultimately call it), millions of people 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 can’t be ignored.
For tax purposes, as soon as you make your home available and start to advertise it, you’re 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. If you paint the entire home, only the pro rata share of the paint job that applies to the rental area is deductible against your rental income. The same allocation must be made for all of the homes expenses, like water or utility bills, property taxes, or mortgage interest.
You’ll also get to depreciate a portion of the home. This may feel good as you’re reporting rental income, but if you sell the home, the depreciation deduction will reduce your basis and potentially cause part of your gain to be taxable.
Beyond the income tax consequences, there are risk management considerations that may impact your decision to enter this rapidly growing market. Your primary residence insurance may not cover you for using the property as rental property. Furthermore, what type of rental property are you? Are you traditional, hotel, or a bed and breakfast type of landlord?
Since short term stays and frequent turnovers are common in this 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 property type and location. Not upgrading your policy due to cost is negligent and should be avoided. If you feel that the cost is too high and that your rental income will not justify the expense, then you probably shouldn’t rent at all.
On the other hand, if you do upgrade your policy, consider asking a risk professional to walk the property with you and do a risk assessment. In this assessment, you’re looking for things on the property that may be a risk catalyst. A jet ski or a snow blower, 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.