How is the rent from my ADU or the other unit taxed?
As income, after the costs of earning it. You report the rent you collect. The costs of the rented part generally count against it, including depreciation, a yearly deduction for wear on the building. Tax is figured on what is left.
WHAT MOST PEOPLE ARE NEVER TOLD
The IRS treats a home you live in and partly rent out as two properties: a home and a rental. When you sell, it counts the depreciation you were entitled to take on the rented part, whether or not you took it.
IRS Publication 527 splits a home with a rented part in two. Costs that belong only to the rented part count in full. Shared costs are divided by a reasonable method, and square footage is a common one. These generally count against the rent:
- The rented part's share of loan interest, property tax and insurance.
- Repairs and upkeep on that side.
- Depreciation on its share of the building, never the land.
When you sell, IRS Publication 523 has you divide the sale between the part you lived in and the rented part. Gain on your part can be left untaxed under the main-home exclusion, up to a limit, if you meet its ownership and use tests. Gain on the rented part is generally taxed, including gain equal to the depreciation.
Texas has no personal income tax, so the state does not tax your wages or your rent. Colorado has a state income tax, and rent is part of the income it taxes.
Keep records from the first month: every receipt, and how you measured the split. A tax professional will ask for both.
GOOD TO KNOW
Depreciation lowers the tax on your rent now and comes back as tax when you sell. A loss on the rented part may be limited in the year it happens. The rules change if you move out and rent both homes. A tax professional decides what applies to your return, so ask one before you file.
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WHERE THIS COMES FROM
- IRS Publication 527, Residential Rental Property: rental income, expenses, depreciation, and renting part of a property
- IRS Publication 523, Selling Your Home: business or rental use of a home, and depreciation
- IRS, Frequently asked questions: Sale or trade of business, depreciation, rentals (depreciation allowed or allowable counts at sale)
- Texas Constitution, Article 8, Section 24-a: no tax on the net incomes of individuals
- Colorado Department of Revenue, Individual Income Tax Guide
Researched and written by Series Homes. Checked against its sources on . Lending rules change. This page is general information, not a loan offer or legal or tax advice.