Live-in landlords are becoming more common these days, as more and more people choose to lease out rooms in a house that they own and live in. It can help pay the mortgage, help cover running expenses and fill up space that are otherwise unused. If you lease out part of your home, the rent received is treated as “assessable income” by the ATO.
That is why it is important to learn the basics about your live-in landlord tax obligations, come this tax time…
What changes at tax time?
When you rent or lease out your room(s), you will receive a payment in the form of rent from your tenant. The rent money, you receive is classified as income and it must be claimed on your tax return. Specifically, at Item 21 (Rental Schedule) on your tax return.
Next, you are able to claim deductions against this income received to help your refund.
As a landlord, you need to keep good records
You will want to stay on the ATO’s good books. The absolute number-one habit that makes those things possible is a steady habit for keeping receipts and records. It doesn’t need to be hard or complicated! Just keep receipts and a short note about any expenses or costs relating to the renting of the space — plus a record of any rental income you have receive.
Remember, no receipts mean no tax deductions. So, keep them all. If you are in doubt about whether a receipt might be claimable, keep it anyway. Your tax agent can advise whether you can use it, later, to help boost your tax refund.
Claiming your live-in landlord tax deductions: The Apportion Method
There are lots of tax deductions you can claim as a live-in landlord by using the “apportion method” Sounds scary? Don’t worry, it is simple.
The apportion method is a common way of separating tax-deductible expenses between the rental and personal use. As a general approach of determining this, the apportionment should be made on a floor basis (the space in which your tenant takes sole occupancy) with a reasonable figure for access to other general living areas including the garage and outdoor areas. This means you are including the tenants living area along with an appropriate estimation of other living areas that you share together, of which if someone is sharing with one other person, the apportionment would typically be 50% of the shared spaces.
If the tenant is also paying for part of your running costs (electricity, internet, heating etc) as either a fixed weekly/monthly amount or as a percentage of the bills, you’ll need to treat this the same as rental income. Ensure you claim both the income and the deduction for these expenses.
One live-in landlord’s taxes: An example
John owns a two-bedroom house. He rents out one bedroom for $150 per week to a person for the financial year. The floor area of the rented bedroom is ten square metres – and which is twenty per cent of the total floor area of John’s house.
John’s expenses include his mortgage, building insurance, rates and taxes, totalling $25,000 for the year.
So, what should he enter on his tax return?
- Income: John enters $7,800 of rental income under item 21 in the income section of his tax return. ($150 rent x 52 weeks)
- Deductions: Then he should enter $5,000 (20% of his $25,000 expenses) as tax deductible expenses.
What kind of tax deductions can a live-in landlords claim?
When it comes to claiming deductions, remember to keep all your receipts. Set aside the time to work out what percentage of your expenses are claimable throughout the year so when tax time comes around, it’ll be easy to lodge your return.
Some common deductions include:
- Internet and phone costs
- Water, power and council rates
- Upkeep and repairs of the property
- Depreciation on the cost of furnishings and equipment
- Interest on your mortgage
- Body corporate fees (when applicable)
What if you are renting out a room to family or friends?
Renting to friends or family at a discounted or less than market rate might seem like the right thing to do sometimes. However, from the ATO’s perspective, that may limit the deductions you are able to claim.
When you claim property-related tax deductions, the ATO assumes you should be making the most of your property’s investment potential. If you intentionally receive less than market rent, the ATO requires that your expenses are adjusted downward by the same proportion that your rent sits below market rates.
For example, if you rent a room to a cousin at half of the market rent, you must divide your deduction claims in half as well.
Or, if you rent a room to your mate for 25 per cent less than the market rent, then all your rent-related deductions need to be adjusted down by 25 per cent as well.
How do I find the market rate for renting a room?
First, look on realestate.com.au. Check out comparable properties in your area and be fair and honest with yourself about it. (Remember, the ATO can look it up just as easily, and compare the information to your house. The internet keeps you honest, so be honest and avoid any future trouble! Another approach is to ask your real estate to recommend your market rent in a short letter. You can then provide this to your tax agent, and you should be set for whatever the ATO throws at you about market rents.
Working out your live-in landlord tax deductions when renting to family or friends can be tricky. Make sure you ask your tax agent for help if you’re not sure. It’s always better to get this section right in the first place, rather than face any ATO issues further down the track.
Am I liable for capital gains tax?
When you are selling the house, that was your own main residence, you are not usually liable for capital gains tax (CGT) deducted from the selling price. But as soon as you start renting space, it can get a little bit more complicated.
Unfortunately, if you decide to earn a bit of income by renting out a room or two, you are no longer entitled to the full “main residence exemption.” This means when you sell the house you may need to pay some CGT, at a rate that is adjusted based on how much of your house was rented and for how long.
To work out how much CGT you might be liable for, you will need to take into account a number of factors:
- Determine the area of the total floor area that is set aside to produce income (i.e., 10%)
- The duration in which you’ve used this floor area (days per year)
You will then be able to work out the total number of days your property was rented out, out of the total number of days you owned your property.
As for our example above:
John’s rental space is twenty per cent of his home. He owned the property for five years and rented out the room for four years total (1,460 days out of the 1,825 he owned it).
When he sells after five yours, he will be liable to pay twenty per cent of the full CGT for the property – only for the 1,460 days when he rented the property.
Please note this only applies to properties that have been rented after 20 August 1996.
Before you rent out a room, weigh up all the costs and benefits
Being a live-in landlord can offset some of your household costs with the rent income while creating tax deductions for some of your expenses. But as we outlined above, there are down-sides including the future cost of CGT. Enter “with eyes open” and decide what’s best for you in the long run. In particular, be careful about renting a room to a friend on the cheap; this has all the tax costs, but fewer tax benefits for you.