As rental prices continue to soar in many regions, you might consider renting your property to financially struggling family members at a discounted rate. While this arrangement can provide much-needed relief, it also presents potential tax challenges. Missteps can lead to losing significant tax deductions. Here's an overview of the tax implications of renting to unrelated parties versus relatives and how to navigate these situations.
Business vs. Personal Use
Strictly Business Use: If you use real estate exclusively as a rental property, you must report the income and can deduct related expenses such as mortgage interest, property taxes, utilities, depreciation, and maintenance costs. Should your expenses surpass your rental income, you can typically claim a loss, subject to certain limitations.
Personal Use: For properties used as a personal residence and rented out for fewer than 15 days per year, you are not required to report the rental income. However, you also cannot deduct rental-related expenses. If you itemize, you can still claim personal deductions for mortgage interest and property taxes, subject to limitations.
Mixed-Use Property: If you rent out your personal residence for 15 or more days per year, the property is considered mixed-use. You must report the rental income and allocate expenses between personal and business use. The personal portion of expenses can be claimed as itemized deductions, while the business portion is deductible as rental expenses. However, rental expenses cannot create a tax loss; disallowed deductions may be carried forward to future years.
Family Matters
Renting to family members comes with unique challenges. Use by family members is generally considered personal use, even if they pay rent, unless both of the following conditions are met:
- The family member uses the property as their principal residence.
- They pay fair market rent (not a discounted rate).
If these conditions are not satisfied, you must report any rental income received if the property was rented for 15 days or more annually. However, you cannot deduct related expenses.
To safeguard your tax benefits, it's crucial to set rent at or above the fair market value. Documenting comparable local rental rates can help establish that you're charging a fair market rent. Be cautious about providing financial gifts to help family members with rent, as the IRS may interpret this as a discount, jeopardizing your ability to deduct rental expenses.
Know What You’re Getting Into
Assisting family members with housing expenses can be a generous and compassionate choice. However, it's essential to understand the tax implications of renting to relatives. Consult with your tax advisor to ensure you're making informed decisions and preserving your tax benefits.
The HoganTaylor Tax Practice
If you have any questions about the content of this publication, or if you would like more information about HoganTaylor's Tax practice, please email Tony Otto, Tax Practice Lead, at jotto@hogantaylor.com.
INFORMATIONAL PURPOSE ONLY. This content is for informational purposes only. This content does not constitute professional advice and should not be relied upon by you or any third party, including to operate or promote your business, secure financing or capital in any form, obtain any regulatory or governmental approvals, or otherwise be used in connection with procuring services or other benefits from any entity. Before making any decision or taking any action, you should consult with professional advisors.
