Renting Out Part of Your Home: The Tax Treatment Nobody Explains
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With New Jersey housing costs where they are, the accessory apartment is having a moment — the finished basement with a kitchenette, the in-law suite, the room listed on Airbnb during peak weekends. The income is straightforward. The tax treatment is not, and partial-home rentals are among the most consistently misreported items we see on self-prepared returns.
The core concept: your home becomes two properties
The moment you rent a portion of your home, the tax code treats you as owning two assets: a personal residence and a rental property. Every shared expense must be allocated between them — usually by square footage, sometimes by number of rooms.
Rent goes on Schedule E. Against it you deduct: 100% of expenses that belong solely to the rented space (repairs to the unit, its utilities if separately metered) plus the rental percentage of shared costs — mortgage interest, property tax, insurance, utilities, repairs to shared systems. A 25% rental allocation converts a quarter of your homeowner costs from mostly-nondeductible personal expenses into rental deductions. In a high-cost NJ home, that allocation is worth real money — and note that the property tax slice moving to Schedule E doesn’t consume your SALT cap.
Depreciation: not optional
Here is the rule that surprises everyone: you must depreciate the rental portion of your home (its allocated basis over 27.5 years), and when you eventually sell, the IRS applies depreciation recapture on the depreciation you were allowed to take — whether or not you actually took it. Skipping depreciation “to keep things simple” means paying tax later on deductions you never received. If you’ve been renting for years without depreciating, this is fixable prospectively (a Form 3115 catch-up), and it should be fixed.
Short-term is a different animal
Airbnb-style renting layers on its own rules:
• The 14-day freebie: rent your home (or part of it) fewer than 15 days in the year and the income is entirely tax-free — unreported, no deductions either. One of the few true gifts in the code.
• Substantial services (daily cleaning, meals, hotel-like amenities) can push the activity from Schedule E to Schedule C, adding self-employment tax.
• Average stays of 7 days or less follow different passive-activity rules — occasionally an advantage for owners who materially participate, but a trap for the unaware.
• NJ imposes state-level taxes and fees on many short-term rentals (marketplaces often collect them, but not always), and municipalities add their own registration and inspection requirements.
When you sell
The home-sale exclusion (up to $250K/$500K of gain) still generally covers gain on space within your dwelling unit — but never covers depreciation recapture, and separate structures (a rented carriage house) are treated as a true sale of rental property for their share of the gain. The allocation decisions you make today write the tax story of your eventual sale. Keep the file.
The record set that makes this easy
Square footage worksheet, dated. Rental listing history and days rented. Separate ledger of unit-only vs. shared expenses. Depreciation schedule. That’s it — an hour of setup, and the return becomes routine instead of guesswork.
Romanchuk CPA LLC prepares returns with rental income of every shape — including the partial-home rentals most software mangles. If yours has never been reviewed by a professional, book at rfg.tax; the depreciation check alone is worth the visit.
This article is general information, not tax advice for your specific situation.