- Check out the facts
First of all, you should research the financial and tax implications for your situation to make sure that you can take in a lodger. For example, your mortgage might preclude you from taking on a lodger.
“Research these things – as well as your rights and responsibilities as a landlord, to avoid problems in the future,” says Michael Quinn, co-founder and director of the Quinn Group. “A good place to start is the Fair Trading organisation for your state”.
- Taxable income or incidental revenue?
Before you rent out a room, it’s worth being clear how the income will be classed – and most importantly, whether you should pay tax on it.
“If you are receive income from say your children as board then this income would not be taxable,” explains Ken Raiss, director at Chan & Naylor accountants. “If you rent out a room to a third party under an agreement then the rent received would be taxable income.”
Raiss adds that, in the latter case, would be entitled to deduct expenses such as interest expense, council rates and so on a proportional basis, however.
The situation differs from using your home to run a business such as a childminding business, adds Raiss.
“If you use your home (no specific area) to run a business then you would not normally be entitled to claim your expenses and similarly you would still be entitled to claim the full main residence tax exemption,” he says. “If, however, you used a specific part of the home and it was therefore not readily available for your personal use then expenses can be claimed.”
- Work out the split
In order to work out this proportion, you’ll have to calculate how much of your property is counted as income generating.
This could take into account the actual area used and would take into account two main components. The first is the actual area for the sole use of the tenant – such as the bedroom and any ensuite; the second will be the common areas used, such as the living room, kitchen and so on.
“The specific area is calculated by using the actual square metres of the room/s and the common area would be the total other areas divided by the number of people who could also use that area,” says Raiss.
- Capital gains
One major implication of renting out part of your home that you should consider carefully is the impact on its tax status. Main residences are usually exempt from capital gains tax on sale: however, if part of it becomes income generating, it’ll be subject to capital gains tax.
Like tax-deductible costs, this is also worked out on a proportional basis.
- Land tax
Finally on the tax front, if you’re using part of your home to generate taxable income, you’ll lose the land tax exemption on your PPOR – again on a proportional basis.
- Never knowingly underinsured
Assuming that you’re willig to deal with the tax implications, you then have to consider the practical implications. First up, check your home and contents insurance cover and make sure the policy will sufficiently insure you if you take in a lodger. Some policies require that you inform the insurer of any changes taking place that may affect the insurance: failure to do so may invalidate your policy.
- Vet your lodgers
Always interview your potential renters and check references and credit history. This is potentially more important than if you’re renting out an investment property: after all, you need to be able to live with this person, as well as rely on them to meet their responsibilities as a tenant. Be mindful in making your selection.
- Everything in writing
Draw up a rental contract with all terms clearly defined, just like you would for a separate property. This is essential regardless of any pre-existing relationship, says Quinn.
“Even if you are already friends with, or familiar with the lodger, it’s recommended that you use a complete contract that displays all terms and conditions,” he says.
- Ground rules
Set clear boundaries and rules for things like food, cleaning, storage, noise and visitors. Some of these things may seem finicky, but they do save tension and arguments in the future. Establishing boundaries and procedures smoothes the path for the entirety of the rental term.
- Stay on target
Just because someone’s staying in your home doesn’t make them a guest. Ensure that rent is paid on time, and be prepared to evict your lodger in the same way as you would a bad tenant in an investment property should things go sour. If you do have to evict your lodger, make sure you’re doing so in accordance with your state’s tenancy laws.