The Tax Guy: Renting to Family Members Can Be Taxing

The Tax Guy

One way to weather a soft residential selling market is to rent out your present home until the market improves.

Renting out a home that you own may result in a tax loss for you, even if the rental income is more than your operating costs. This is because you will be entitled to a depreciation deduction for your cost of the house (except for the portion allocated to the land). And many people turn to family members first, however, if your tenant is related to you special rules and limitations may apply. (For these purposes, "related" means spouse, child or grandchild, parent or grandparent, and siblings.)

Here's the tax picture:

If you rent a home to a relative who (1) uses it as his or her principal residence (that is, not just as a second or vacation home) for the year, and (2) it's rented at a fair rental (not at a discount), then no limitations apply. You can deduct all the normal rental expenses, even if they result in a rental loss for the year.

The problem arises if you set the rent below the fair rental value. Since this then becomes a rental property which you are treated as using personally, you would have to allocate the expenses between the personal and rental portions of the year. Even more seriously, however, since all of the rental days (at a bargain rate to a relative) are treated as personal days, the rental portion is zero. Thus, you would have to report all of the rent you receive in income, but none of your expenses for the home would be deductible (Actually, you would still be able to deduct the mortgage interest, and property taxes. These items are deductible even for non-rental homes on your Schedule A.).

Given the above, it is important to set the rent at a fair rate. Factors to look at include comparable rentals in the area, and making sure rent payments at least are covering monthly mortgage for property. Rent payments which do not cover the landlord’s basic expenses may be assumed to be under fair market value.

"The Tax Guy" is a new column on PhxSoul.com that will provide useful, professional tax tips and accounting advice.

Jermaine A. Southern a.k.a. "The Tax Guy" is a Certified Public Accountant (CPA) living in Phoenix, Arizona. He received his B.A. in Accounting from Morehouse College, and graduated from Arizona State University's W.P. Carey School of Business with a Masters of Taxation. He has been in public practice for more than nine years along the way working at both international (Deloitte & Touche LLP) and regional (Clifton Gunderson LLP) firms. He is now principal of his own private practice. The Tax Guy's articles do not necessarily reflect the views of PhxSoul.com. Please visit southerncpafirm.com to reach Jermaine for additional questions with regard to this article or other tax assistance.