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Tax Talk with George Saenz

Ask the tax adviser

Rental vs. personal property use

Dear Tax Talk:
I am in the process of purchasing a second home for our two sons who attend college. We are considering renting out two of the rooms to other students. Would it be better to keep the house solely for the purposes of our sons, thus being able to deduct the full interest, or claim it fully as a rental property, taking the depreciation and upkeep deductions? Or would it qualify as a part personal use, part rental property whereby we could deduct some of the mortgage interest and also some of the depreciation and upkeep?

Dear Ric:
In more than 15 years of practice, I have never had a clear answer on the situation you describe. In effect, you will be taking on boarders that will use a portion of the home, which should make the property part rental property. If two of the rooms represent half the home, then half of the expenses should be reported as rental property expenses on Schedule E against the rent received.

Rental expenses would include mortgage interest and taxes, which are otherwise deductible without regard to the rental activity (the interest being treated as second home interest), insurance, association dues, utilities and also a deduction for depreciation. Since the residence is used in part for personal purposes (your sons occupy the home), the law does not permit a loss from the rental activity.

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Alternatively, if your sons just took on roommates or persons that were allowed to use the home rent-free, then you wouldn't have the rental activity issue to deal with. Obviously, the roommates would make some sort of contribution to the household, such as food or utilities to justify their use of the property. However, what is not clear is if the Internal Revenue Service would try to recharacterize this as a rental activity and deem this other support as disguised rent. Your counter argument would be that the roommate relationship is not a business relationship and therefore should not be treated as a rental activity.

For example, assume your sons allowed their girlfriends to live rent-free in the house. Why would their contributions to household expenses result in income when it is a personal relationship? My opinion is it should not be a rental activity. The benefit for you would be that you would not be reporting rental income and would be claiming a deduction for the interest and taxes. You should probably discuss your options further with your professional tax adviser.

Home sale exclusions for separate filers

Dear Tax Talk:
If you are married but separated and each spouse lives in a separate home (but owned by both) and each meets the requirements of two years living in and owning each home, would each one be entitled to up to $250,000 gain without tax?

Dear Carol:
An individual is allowed to exclude up to $250,000 in gain from the sale of a principal residence that he or she has owned and lived in for two of the last five years. A married couple filing a joint return can exclude up to $500,000 in gain, which can be from the sale of two residences, up to $250,000 in gain on each. A married couple filing separate returns can each exclude $250,000 in gain from the sale of their joint or separately owned residence.


-- Posted: June 22, 2002

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