“How do I pay taxes on a rental property when I live in part of it?”

I broke this answer up into five parts, this is what you need to understand to do your to taxes on a combo owner occupied and rental property.  Real estate investors have to pay taxes too lol.

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While you may not think this comes along often, it is a common situation and question when a (usually) beginning real estate investor has a rental property and they live in part of it while renting out the rest.  This may seem a little complicated when you’re the investor involved and tax season is approaching, but this can be done really easily.

The question: “How do I pay taxes on a property I live in and rent out as well?”

Here’s the five part answer below…

Tax deductions for an owner occupied rental are going to be a five part tax preparation.

Part 1

The resident part of the property the owner is occupying, will be treated as a conventional single family residence in accordance with IRS tax laws.

This means that any deductions that you would normally have, itemize and write off for your home (as a single family residence) you would still be able to write off just the same in this situation.  So everything is normal regarding this portion of the rental, as if it were your single family residence.

Part 2

The rental portion is going to be treated as an investment rental income generating property.  So you are going to need to file a schedule E Form for this.  I included a link to one below.

Part 3

Pro-rata share is something you need to know about, it is Latin and translates to in proportion, this basically describes a part a fraction of something compared to the entire thing.  In this case it means that we need to determine what portion rental property is being used by the owner.

For example, if the owner was paying all utilities, and the rental space was 50% of the total property, the pro-rata share of the utilities (in the form of expenses related to an income generating property) would be 50% of the total utilities bill. 

Part 4

Mortgage interest and property taxes are important here as well.  While using the same pro-rata percentage, the owner area/unit/portion of the mortgage interest and property taxes will be deducted on the standard schedule A Form.

The rental income portion of the property as it pertains to the remaining amount of mortgage interest and property taxes will be filed on the standard E Form.

This is why determining the exact, mathematical amount or percentage of the property that is being used by the owner versus the tenants.

Part 5

Depreciation.  This will work the same for this kind of living and rental property arrangement as the above. The portion of the property that is rental income generating will be depreciated (the standard amount of the building NOT the land divided by 27.5) for tax purposes.

For more on depreciation, I did a class on that you can watch here.

So for example, using the standard deprecation equation, if a property is worth $400K and the building is worth $300K while the land is worth $100K, then the deductible amount for the same 50% owner/rental pro rata ratio is $2,727.50 (50% of $5,455).

That is $300k divided by 27.5 = $10,909

We then divide $10,909 by 2 (50%) and get $5,455.

So remember…

In an owner occupied rental where you’re wanting to use pro-rata guidelines for tax purposes, there must be itemization used to legally deduct things – and you have to be following standard form itemization principals.  Separate your residence and treat it almost like an entire different property.

Pretend that the part you live in is detached and across the street.

Since you are now claiming deductions from two different tax categories or pools, the need for separating the two out with itemization is crucial in order to stay out of trouble.  This is how you file your tax returns on a rental that you also live in, done correctly you can benefit from each of the scenarios be a good example of the owner occupied rental situation working out well.

Helpful places:

https://www.irs.gov/pub/irs-pdf/f1040se.pdf (schedule E form)

https://www.irs.gov/pub/irs-pdf/i1040se.pdf (schedule E form instructions)

https://www.irs.gov/pub/irs-pdf/f1040sa.pdf (schedule A form)

https://www.irs.gov/pub/irs-pdf/i1040sca.pdf (schedule A form instructions)

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