She Wants to Rent Two Bedrooms to Nursing Students for $1,800 a Month and Still Live Down the Hall. When She Sells, the Whole Gain Will Still Be Covered by Her $250,000 Exclusion

A lot of people approaching retirement ask about renting spare bedrooms. The house is already paid for, the kids have moved out, and there’s a hospital or nursing school a short drive away. Students on clinical rotations want a furnished room close to campus, and a homeowner with two empty bedrooms can turn them into regular income.

She rents two rooms to nursing students for $1,800 a month combined, keeps living in the home, and later sells with the gain sheltered by the $250,000 single-filer exclusion. The tax code mostly supports this. One item it leaves out shows up at closing.

How Much Portfolio Two Bedrooms Replace

Take a single retiree eligible for full Social Security benefits with a working budget of about $60,000 a year in current dollars. That covers property tax and homeowners insurance, food and utilities for a three-person household, and Medicare Part B at $202.90 a month, or $2,434.80 a year, before a supplement and a drug plan. It also covers a reserves fund for the roof, appliances, a replacement car, gifts, and the income tax owed on withdrawals. Wear and tear runs faster with three adults in the house, so that fund has to be real money.

Social Security at the average retired-worker benefit of $2,071 per month comes to $24,852 a year. Add $21,600 in gross rent, and the remaining gap is $13,548. At a 4% withdrawal rate, that works out to a portfolio of about $338,700. Without the tenants, the same budget needs roughly $878,700. So the two rooms are doing the work of about $540,000 in invested assets, as long as they stay filled. Student demand follows the academic calendar, which means summer vacancies are the main risk to that income.

What the IRS Taxes Each Year

Rent is taxable income, reduced by expenses under Publication 527. Those include the rooms’ share of utilities, insurance, and repairs, plus depreciation. For example, assume $4,000 in allocated expenses and assume the rooms account for 25% of a $300,000 building basis, depreciated over 27.5 years. That depreciation comes to about $2,727 a year, which leaves roughly $14,873 in taxable rent.

That rent also changes how her Social Security is taxed. Half her benefit plus net rent plus portfolio withdrawals gives provisional income near $40,847. That’s above the $34,000 single threshold, so up to 85% of her benefits can become taxable. The added $6,000 senior deduction softens this through 2028. It phases out above $75,000 of MAGI, which this plan stays well below.

Recapture Line Most Room Renters Miss

At sale, Treasury Regulation §1.121-1(e)(1) requires no split of the gain between personal and rental use when the rented space sits within the dwelling unit. Bedrooms down the hall count as part of the home. That’s why the headline’s promise holds for the gain itself.

Depreciation is the exception. Under §121(d)(6), depreciation taken after May 6, 1997, is recaptured and can’t be excluded. After ten years in this example, that’s about $27,273, taxed at up to 25%, or about $6,818. Depreciation also reduces her basis, which increases the reported gain. A gain that would have fit under the cap on the original basis can exceed it once you add back depreciation. The IRS applies recapture to allowable depreciation, so skipping the deduction still triggers the tax and only gives up the annual write-off.

A different setup brings a larger problem. A basement apartment with its own entrance is a separate unit and requires allocation. The gain on that portion is taxable. Rising home prices make the cap matter more. Home prices, as measured by the Case-Shiller national index, were at 336.7, its high for the period, while existing-home sales ran at a soft 3.98M annualized. Gains keep building even as sales activity slows.

What It Takes to Make This Work

At the average benefit claimed at eligibility for full benefits, the plan needs about $340,000 invested and a 4% withdrawal rate. It also needs rent that stays close to $21,600 a year. Waiting until 70 to claim Social Security raises the benefit to about $30,816 a year, based on delayed retirement credits. That cuts the gap to roughly $7,584 and the portfolio target to near $189,600, with a cash or treasury ladder covering the years in between.

Three conditions keep the exclusion working:

• The rented rooms stay inside the living space, with no separate entrance or kitchen.
• Gain above the original basis, plus the depreciation added back, stays below $250,000.
• Set aside about $7,000 for the recapture bill at sale.

The exclusion covers the appreciation, but depreciation still gets taxed, so plan for that bill from the first year of renting.

Contact [email protected] for any questions or corrections.