So you’re thinking of renting to relatives and want to know the tax implications After all, it’s something that seems to make perfect sense. Your child; or maybe it’s your mother or a cousin needs a place to stay and you have a rental property.
If you were to let them live there rent-free, or maybe for reduced rent, you’d be doing them a tremendous favor, and they’ll be able to look after your property for you; helping to keep it in great condition. It’s the best of both worlds.
But while your plan does make sense, there’s just one problem: if you’re not careful, renting your home out to family could mean that you’re no longer eligible for certain tax deductions.
While tax law allows generous tax deductions that many landlords are eligible for, it also has strict criteria that it insists landlords meet in order to remain eligible for those deductions. There are a number of things that a landlord could do, even unwittingly, that could push the property outside the definition of a rental, and into the criteria of a personal residence; eliminating many of these tax deductions.
Let’s take a look at renting to relatives and the tax implications to ensure that you’re eligible for those valuable deductions.
What’s Considered a Rental?
First up, let’s take a look at what, exactly, the IRS considers to be a rental property.
A property is considered to be a rental if it is rented during the year in question, and used by the owner less than the greater of 14 days – or 10% of the number of days that the unit was rented to others; as long as it was rented at fair rental value.
If, however, you occupy the property yourself for a portion of the year – or rent it out for a reduced rent, then limitations may apply to a number of expenses that you’re able to deduct.
Additionally, if the property is mixed use, then it may be rented and used by yourself for more than 14 days of the year, however, it’s important to note that expenses like insurance, mortgage insurance, taxes, and more will be allocated between rental and personal use.
It’s also important to note that if the property’s rented out for fewer than 14 days during the year, then it’s considered a personal residence, and as such you won’t be able to claim as many tax deductions; only mortgage interest and property taxes. You also won’t be required to report any rental income.
However, complications arise when you are renting to relatives.
These issues usually surround the question of “fair-market-value rent,” and how the IRS classifies rental properties that are rented for less than this amount. Normally people decide to rent out to relatives because they’re looking to give that family member a good deal. But it’s important to realize that for each day that you rent the property for less than its fair market value is considered a personal use day.
Too many personal use days, can quickly push the property into the category of personal use. This could mean that you’d end up having to claim the rent as income, but not being able to claim many of those value tax deductions.
Rental Property Deductions
Part of the appeal of rental properties is the myriad of valuable tax breaks that landlords are eligible for. Some available deductions that many landlords are able to take include:
- Mortgage interest
- Property taxes
- Utilities (If you pay them)
- Maintenance and repairs
- HOA fees
- Professional and legal fees
- Some travel expenses to and from the rental
These deductions can add up quickly and make a real impact on the amount of tax that a landlord owes at the end of the year. However, if your rental loses its status as a rental, then most of these deductions will disappear. The exceptions are mortgage interest and property taxes, which you’d be able to claim anyway.
Tips for Keeping Your Rental Property Deductions
If you’re looking to ensure that your property keeps its rental status –and your rental expense deductions intact, the good news is that you can rent to a family member; there are just certain rules that you should follow.
First of all, in order for the property to be considered a rental, you cannot use the property yourself for more than 14 days –or more than 10% of the total days that you rent it to others at a fair rental price.
If you’re not residing in the property yourself, then you’ll want to ensure that you abide by the following:
- Charge a Market-Value Rent – And Be Able to Prove It - First up, no matter who you’re renting to, you’ll want to ensure that you’re charging a fair-market-value rent. This applies whether you’re renting to a friend, family member, or any other tenant. The best way to do this is to gather evidence that your rent is at fair-market-value. You can do this by printing or screen capping listings that show properties similar to your own, with rent that’s priced close to your own. Check out a website like Trulia or Zillow to see what other properties are going for. You may also want to get an independent appraisal for the property, just so you’re clear on what a fair-market-value rent is. If you do choose to rent the property to a family member at a rate that’s below market value that’s fine, but you’ll want to make sure you’re aware that you’ll need to reflect this on your tax return –and there will be limitations on how many deductions you’re able to claim.
- Be Wary of Giving Heavy Rent Discounts - While in some cases you may be able to give your friend or relative a “good tenant discount,” be careful that this discount isn’t too heavy. In some cases, 20% has been allowed, but it’s a lot easier to defend a 10% discount.
- Avoid Giving Gifts to Subsidize the Rent - Next, take care that you don’t give your family tenants financial gifts to help them pay the rent. The IRS could deduct the amounts that you gift them from the rent value, which may disqualify your property as a rental; pushing your property into the personal residence category.
- Be Sure the Family Member is Using the Property as Their Primary Residence - Finally, if you’re planning on using the rental property as a rental, and continuing to claim deductions for it, then you’ll want to ensure that your family member using it as a primary residence. If they don’t, each day that the relative spends in the property will be considered a personal use day for you. This means that if the relative stays in the house for, say, four months out of the year, but has their primary residence somewhere else; your property won’t be eligible for the rental property classification anymore.
For more information on renting to relatives and the tax implications, be sure to see IRS Publication 527, Residential Rental Property. Remember, neglecting to categorize your property properly, and taking deductions that you may not be entitled to could land you in serious trouble should the IRS decide to do an audit. Your best option is to be informed, and talk to a tax professional if you’d like to learn more about the tax implications of renting to family members or using the property yourself.
At the end of the day, renting to relatives and tax implications is something that appeals to many. Just make sure you’re going into the decision fully informed about the implications of renting out your property to a relative –particularly how it will impact which deductions you may no longer be eligible for.
Note: This article is intended to inform and to guide; it is not meant to serve in place of tax advice from an attorney or licensed tax professional. Please consult a CPA for help implementing tax strategies, or for more information on how renting out your home to a family member may impact you from a tax perspective.