When you decide to rent to a family member, it may seem like a win-win situation for you and your loved one. You believe your property will be well-maintained by this person you trust, and in return, you could help them by reducing their rent.
However, you as a taxpayer may be unaware that renting to a family member has different tax implications than renting to others. If you are not careful, you may fall into a trap that might reinstate your rented property as a personal residence. If this happens to you, the IRS could deny rental expense deductions worth thousands of dollars.
If your tenant is a relative of yours, special rules and limitations may apply. We will explain some of the tax rules you need to know if you are, or are considering, renting to family.
What Defines a Related Tenant?
Your spouse, parent or grandparent, child or grandchild, and your siblings are all considered your relatives according to the IRS.
Rent to a Family Member With No Limitations
There are no restrictions when renting to family members who use the residence as their primary home for the year. They can not use it as a vacation house or a second home. They must also pay a fair rental rate and not a discount.
All your typical rental expenses are deductible, even if they result in a revenue shortfall for the year. However, if you suffer a loss, it is considered a passive loss and can subject you to a different set of restrictions.
Limitations for Renting to Family Members
For tax reasons, you cannot make the determination on your own that your property is a rental property. Rental homes must be rented out during the tax year, according to 26 U.S. Code 280A. Also, it cannot have the owner using the property for personal reasons for 14 days or more.
Neither can the owner use the property for 10% of the number of days the property was rented at a fair market value during the tax year, whichever is less. If the property qualifies as a rental property, you may be able to deduct certain expenses. The following are deductible expenses that may have inclusion:
- Interest on your mortgage
- Property taxes
- Landscape maintenance
- Utilities
- HOA dues
- Property maintenance
- Depreciation
You Can Lose Money if You Lose Your Rental Status
It’s possible for a property classified as a rental property to lose money if the overall expense exceeds the rental income. Except for the mortgage interest and your real estate taxes, all other deductible expenses will vanish if the property loses its position as a rental property.
The IRS considers a home to be a personal residence if the taxpayer owns it but leases it for less than 14 days throughout the year. This rental income does not need reporting on.
You as the property owner can deduct real estate taxes and mortgage interest as itemized deductions. But, you won’t be able to deduct all the other rental costs that you would be able to deduct if the property has classification as a rental property.
Always Rent at Fair Market Value
When renting to family, you must rent your property at fair market value unless you want to risk losing a significant portion of your rental expense deductions. If you rent for less than fair market value, every day the family member leases the property counts as a day when you, the taxpayer, personally used it.
If you appear to have used the home for more than 14 days, the IRS will no longer view it as a rental property. If you rent at a lower rate than the fair market rate to a relative for more than that, the home in question will be removed from the rental property category. That will cause you to lose all your deductible expenses except your real estate taxes and mortgage interest.
Prepare to Prove the Rent Is at Fair Market Value
You will want to have reliable documentation proving that the rent is reasonable. You can scan or print out information on comparable listings with similar rentals.
Make sure to get letters from other property managers stating that the lease amount is fair. Also, obtain an independent appraisal of your property.
The Relative Should Use the Property as Their Primary Residence
If you want your property designated as rental property for income tax purposes, and you choose to rent it to a family member for the year, the relative must live there full-time. Otherwise, every day the relative occupies the residence will be deemed a personal usage day for the owner, just like renting at a lower than fair price.
So, if the relative lives in the home for only three months of the year and has their primary residence elsewhere, the property will get declassified as a rental property.
Be Wary of Using a Good Tenant Discount
Using what is known as a good tenant discount, you may provide your relative with a modest price break. Although 20% was an acceptable rate in the past, this amount is not a certainty. However, a 10% discount is a safer bet to use and easier to justify.
No Subsidizing the Rent Through Gifts
Do not find yourself giving your family members money presents to assist them in paying the rent after setting a reasonable market value for the rent. The IRS may subtract the amount of the gifts from the fair market rent price, causing your rental home to revert to a personal residence.
Potential Tax Loss
When renting out an apartment or home, you are usually allowed a depreciation deduction for the cost of the home, except for the amount allocated for the land. Even if the income from your rental exceeds your operational costs, this could lead to a tax loss for you.
Think Before You Act
If you are thinking about renting to a family member, do not go outside the set requirements you have for any other prospective tenant. Also, offering a fair market rate is critical; if not adhered to, it will cost you in the long run.
Do you want to rent to a family member but feel stuck in the middle of the process? We can help. We have successfully managed over 3,500 properties owned by local, domestic, and international investors, and are the Memphis area’s go-to property management company.
We take pride in offering the best guidance to people, businesses, and institutions as they make smarter real estate decisions. Contact us, or check out our About section for helpful information.
