Renting a room

[dburd52]

I am trying to figure out how the rental of a bedroom in a client's primary residence is treated. Givens: Rental is at FMV to an unrelated party.

I have submitted this to a research service and believe I have received a contradictory answer.

My primary concern is how this situation is treated upon the sale of the principal residence. Is it just like the sale of a home office? My secondary concern is how is the rental income treated year to year – are losses allowed?

Treasury Reg 1.121-1(e) states that “Section 121 will not apply to the gain allocable to any portion (separate from the dwelling unit) of property sold. (Sec 121 is the principal residence exclusion of gain rules.) But it also says, “No allocation is required if both the residential and non-residential portions of the property are within the same dwelling unit.” This last sentence is the basis on which we no longer have to treat a home office as a separate sale. We only have to recapture the depreciation taken on the home office. I think this is similar to the situation where a room is rented which is within the primary residence dwelling unit. So it seems the question comes down to: Is the rented room a separate dwelling unit or not?

The only argument I could find (not discussed by the rs by the way) that the room might be considered a separate dwelling unit was IRC 280A(f)(1), which defines a dwelling unit and carves out an exception: “The term ‘dwelling unit’ does not include that portion of a unit which is used exclusively as a hotel, motel, inn, or similar establishment.”

My opinion is that the rented room is within the main “dwelling unit” and gets the same treatment as a home office upon the sale of the home. And no losses are allowed from year to year. (Or, if it is a separate dwelling, it is treated like a regular rental property on sale, and losses are allowed each year.)

The research service says it is treated as a separate sale, just like a 2 family house. That is pay tax on the gain. But in the same answer, the rs says that the taxpayer cannot claim a rental loss for the room.. They use the vacation home rules which say if there is personal use of a dwelling unit by the owner, no loss is allowed.

Any opinions?

[Gretel]

I agree with your conclusion: no loss allowed, no gain to be reported when sold.

There are new rules for Sec.121 in regards to rental use but I think this only applies if all of the unit is used as rental, not sure though.

[solomon]

My primary concern is how this situation is treated upon the sale of the principal residence. Is it just like the sale of a home office?


My secondary concern is how is the rental income treated year to year – are losses allowed?

No 4797 required upon sale but unrecaptured 1250 gain can not be excluded. I am guessing that under the new Housing Assistance Tax Act, perhaps non-qualified use might apply to the rental room - not sure. Because no allocation is required upon sale in this case per Reg. 1.121-1(e), non-qualified use probably does not apply.

With rent at FMR, I assume there is no personal use so why would a rental loss be precluded?

I assume this does not fit the up to 7 day or 30 day with significant services etc.

[Gretel]

Pub. 527

See Pub. 527 "personal use of dwelling unit": "Limit on deductions. If your rental expenses are more than your rental income, you cannot use the excess expenses to offset income from other sources. The excess can be carried forward to the next year and treated as rental expenses for the same property"

[solomon]

See Pub. 527 "personal use of dwelling unit": "Limit on deductions. If your rental expenses are more than your rental income, you cannot use the excess expenses to offset income from other sources. The excess can be carried forward to the next year and treated as rental expenses for the same property"

Does not renting at FMR remove it from "personal use" and take it from §280A to §212?

[Gretel]

Does not renting at FMR remove it from "personal use" and take it from §280A to §212?

I don't think so. As long as the landlord occupies the dwelling unit at the same time as the tenant you have personal use. I did that wrong some years ago and was glad when the statute of limitation expired.

[solomon]

I don't think so. As long as the landlord occupies the dwelling unit at the same time as the tenant you have personal use. I did that wrong some years ago and was glad when the statute of limitation expired.

See TTB 1040 Edition Page 7-7. There is discussion and an example of renting part of a residence. Note, it is not under the section §280A for mixed use property. In other words, the rented room does not fall under "personal use" for the rest of the residence. It is not mixed use property.

Sticking with the example of only $270 expenses, assume the FMR were $50 monthly and tenant moves out after 4 months. Landlord advertises the rental room but has no takers. This leaves a $70 loss for the year. Would not the following portion of Reg. 1.212-1(b) apply. Substitute room for building.

Similarly, ordinary and necessary expenses paid or incurred in the management, conservation, or maintenance of a building devoted to rental purposes are deductible notwithstanding that there is actually no income therefrom in the taxable year, and regardless of the manner in which or the purpose for which the property in question was acquired.

[abby]

agree with Soloman

Look in Pub 17 for examples. If you rent a room at FMV, that room is like any other rental. An example for personal use in the pub, would be renting out your basement to a lodger and then letting your brother stay there after the lodger moved out. Then the vacation home rules would kick in.

All normal rental expenses, including a portion of the household utilities, insurance, etc and depreciation for the room (based on a reasonable method, like square footage or number of rooms in the house) would be allowed. 100% of any expense that applied directly to the room would be allowed. No depreciation would be allowed for common areas used by the tenant like the kitchen, bathrooms would be allowed, because they do have personal use.

I've also seen (can't recall the pub) that starting to rent a room in mid year doesn't automatically trigger personal useage, you would have to prorate the expenses for the partial year, but the exclusive use as a rental starts when the room is first put into service as a rental.

As for sec 121, it appears that the rental within the household would receive the same treatment as a home office - at least until the new rules kick in.

[solomon]

I've also seen (can't recall the pub) that starting to rent a room in mid year doesn't automatically trigger personal useage, you would have to prorate the expenses for the partial year, but the exclusive use as a rental starts when the room is first put into service as a rental.

It is probably in some publication but the original source I believe is an old Prop. Reg. 1.280A which reads in part:

(4) Special rule for “qualified rental period.

“ For purposes of determining whether section 280A(c)(5) and §1.280A-3(d) limit deductions for expenses allocable to a “qualified rental period,” a taxpayer shall not be considered to have used the rented unit for personal purposes on any day during the taxable year before or after a “qualified rental period” described in paragraph (e)(4)(i) of this section, or before a “qualified rental period” described in paragraph (e)(4)(ii) of this section, if the rented unit was the principal residence of the taxpayer with respect to that day. The use of the unit for personal purposes shall, however, be taken into account for all other purposes of section 280A.

A “qualified rental period” is a consecutive period of —

(i) 12 or more months which begins or ends during the taxable year, or

(ii) less than 12 months which begins in the taxable year and at the end of which the rented unit is sold or exchanged, and for which the unit is rented, or is held for rental, at a fair rental.

[dburd52]

Is room part of home or not?

The Taxbook says (on p 6-22 Delx ed.) "Treatment of gain depends on whether the portion of the home used for business OR rental purposes is PART OF THE HOME, or separate from the home (such as a home office in a separate structure)."
If the portion of the home used for business or rental purposes is within the taxpayer's primary residence, the sale of the home is treated as a single sale."
The examples to show separate use include an apartment building; a store with an upstairs apartment; and a farm. If I recall correctly these examples are taken from Reg 1.121-1.
The IRC or the Regs do not specifically address the rented room situation.
The question comes down to this: Is the rented room considered part of the taxpayer's dwelling unit or is it considered like a hotel room? I don't think it is like a hotel (there are usually no services in these situations which there are in a hotel). I think the rented room is considered part of the dwelling unit.

There is a tax court case, which a colleague pointed out to me on another board, TCMemo 1994-96 which does deal with the renting of rooms. It does not deal with the question of sale though. The Court found that IRC 280A(c)(5) applies in this type of situation and limits the deductions to rental income. This is based on their opinion that the rented space is part of the dwelling unit, and therefore there is personal use and business (rental) use in the same home. (More later.)

[Gretel]

Dwelling unit

I looked at the examples in Pub. 17 and I can't see how they confirm that you have a separate dwelling unit for a room rented out. Normally that room doesn't come with cooking facilities, which is a requirement for a separate dwelling unit.

So it all depends. If you can divide your home into several (at least two) separate dwelling units with separate cooking facilities you may claim a loss.

I strongly doubt that this is normally the case with renting out a room.

[dburd52]

TTB Says

The Tax Book says: "If the portion of the home used for business or rental purposes is within the taxpayer's primary residence, the sale of the home is treated as a single sale."

I would ask the authors of TTB the following questions: 1. In the situation of a homeowner renting out a bedroom, is the bedroom considered "within the taxpayer's primary residence." (It would seem so to me, but does IRS view it this way? Where do they say so?)

2. If the answer to the first question is YES, then on what code, regulation, or case are you basing the statement quoted at the top. This is a quote from page 6-22 of the 2007 Deluxe edition. Everything I can find mentions business use, but not rental use.

[dburd52]

PPC Deskbook says

Hi,

According to a colleague The PPC Deskbook says that in the rental of a room (to a student for example) within a home; the room would constitute a separate dwelling unit even though the room doesn't have kitchen or bathroom facilities. They seem to base this on Prop. Reg. 1.280A-1(c)(2), which carves out an exception to IRC 280A (general rules that limit losses where there is personal use of a residence) where the room is akin to a hotel, motel, etc. PPC says losses are allowed in full, and by extension gain is reported on sale.

On the contrary the following Tax Court cases seem to say the opposite: TC Summary Opinion 2001-114 (Morcos case); Shih TC Memo 1997-181; and Russell TC Memo 1194-96.
I believe these cases say that renting a room does not make the room a separate dwelling; and these situations are subject to IRC 280A. This is consistent with TTB position. Although the TC doesn't get into the exclusion of gain issue.

What do you think?