Sharing utilities with a tenant and paying taxes

[niknak]

My wife and I are currently building a little cottage in our backyard and then will rent out our main 2bd/1ba house. The cottage and the house share the same utility meters. This cannot be changed. We have a few questions about strategies for doing this properly:

1 - How should the tenant pay for utilities? Should we include utilities in the price of rent? Should we go 50/50 on each utility? Any other ways to minimize friction?

2- For tax purposes, since we're living at the same address as our primary residence, do we essentially tell The Man that we're renting out rooms in the house? What's the correct way to lay this out come tax time?

[Johnny Aloha]

1) whichever makes you more comfortable.  We include the utilities for our attached apartment, which is common in our area.  One way to minimize your utility bill risk is to install low flow shower heads, toilets, CFLs/LEDs, etc.  And ask your tenant to be thoughtful about electricity consumption. 

2)* For expenses like insurance, utilities (see #1), wifi, roof repair, etc (and depreciation) ... you can pro-rate it based on house value, or square footage, or some other reasonable method in order to offset your rental income.  If you take the standard deduction instead of itemizing, pro-rated mortgage interest would also be and expense.  If you take the mortgage interest deduction, that will be transparent. 

*You might want to consult a CPA, I'm not one. 

[feelingroovy]

1. I think this will depend on state and local laws.  In my state, if there are any utilities on shared meters, we as the landlord have to pay it, so it's included in the rent.  I agree with Johnny about doing what you can to minimize it.  Luckily, by being next door, you'll notice things like tenants leaving windows open in the middle of winter.

That said, if you can get separate meters, do.  In my experience tenants don't compare apples to apples when looking at the rentals, and won't consider how much they'll save by not paying for utilities.

2. We have a rental on our property--an apartment above a detached garage.  The way my CPA does it is this: he takes the square footage of our house plus the rental, then deducts a percentage of any shared expenses at that ratio.  So for example, the rental is about 1/3 the total square footage, so shared expenses like property taxes, landscaping, driveway maintenance, garbage, etc. are considered rental. 

Any expenses that are directly just for the rental--plumbing repairs, painting, cleaning, etc.--get counted as pure rental expenses.