Payments from renters considered taxable income

I rent my basement to a college student because I'm a nice person and I want to do the kid a favor.  I'm told I have to share some of the money he pays with the IRS. I own the home -- no mortgage -- and I pay for the upkeep. How is it the IRS should get to take some of the money? B.I - Indianapolis  

The rent payments you receive from the college student represent taxable income, just as a paycheck from a job or interest earned on your savings account. As a tax-paying American, the IRS is entitled to a share of that income.  

The upside of having to pay tax on this income is that you also get to deduct certain expenses that may offset the rent income.  

It would be nice if you could just include a little note with your tax return explaining that the rent you received covered your expenses for the upkeep of the basement and there's no tax to pay. But the IRS likes forms and numbers. You'll have to fill out extra forms with your tax return to describe to the IRS how much rent you received and how much it actually costs you to keep that basement in good working order.  The form you will use is Schedule E, Supplemental Income & Loss. On Page 1 of this form you will list your basement as the rental property and show the total amount of rent you received for the year.  

List the amounts you spent for the tenant and the basement portion of your home -- there are probably more deductible expenses than you realize.

• If you paid for a newspaper ad to find a tenant, the cost of the ad is deductible.

• The cost of utilities such as gas, electric, water that relates to the rental portion of the home is deductible.

• Insurance on the rental portion of the home is deductible.

• Repairs to the rental portion of your house are deductible. This might include painting, fixing leaks, plastering, patching cracks, and replacing broken windows.

If your tenant makes repairs for you, you might either reimburse him for the cost or reduce his rent by the amount he spent. If you reduce his rent to pay for the repairs, you still report as income the total amount of rent you would have received, then deduct as a repair expense the amount by which you reduced the rent.

The portion of property tax you pay that relates to the home's rental portion is deductible.

• A separate phone line provided for your tenant is deductible. If your tenant uses the main phone in your house, you cannot deduct a portion of that expense.

• If you had a mortgage, the portion of interest expenses that relates to the rental portion of your house would qualify as a deduction on your rental form.  

Another consideration with your rental basement is depreciation expense.  You are entitled to take a deduction for a portion of your cost of your home, as well as the cost of permanent improvements made to the home. This deduction, called depreciation, is confusing and complicated and it comes with a stinger at the end.  

If you deduct depreciation, you may end up paying tax on part of your sales price when you sell the home -- even though most home sales are now tax-free.  

If you need help calculating depreciation on your home, call the IRS at 1-800-829-1040 and ask for a free copy of Publication 946, How to Depreciate Property, or Publication 17, Your Federal Income Tax. You may also want to request Publication 527, Residential Rental Property. These publications can be downloaded at the IRS Web site, www.irs.gov.