In today’s housing market, it seems simple and straightforward to rent to a family member. Many want to help a relative by charging low-to-no rent (i.e., bargain rent). Despite your best intentions, there are traps in the tax code for renting a property in these circumstances.
Tax rules for renting to a relative
Rental income is reportable on Schedule E of the Form 1040 income tax return. Expenses such as utilities, taxes, and depreciation are deducted from income. Sometimes this results in a loss (known as a “passive” loss) which can be carried forward and used in future tax years. When renting to a relative, special considerations must be taken. “Related” means a spouse, child, grandchild, parent, grandparent, or sibling.
If the rental arrangement conforms to the items below then there are no additional tax considerations for renting to family:
- You rent a home to a relative who uses it as his or her principal residence (that is, not just as a second or vacation home) for the year, and
- The home is rented at a fair market rent amount (i.e., NOT at a discount).
In these cases, you can deduct all the normal rental expenses, even if they result in a rental loss for the year.
Renting below fair market rent
If the amount of rent is below what you would normally rent in the open market, the tax code views this as a rental property that you are using personally. The expenses would have to be allocated between the personal and rental portions of the year. All rent received would be reportable as income. Still, none of the expenses applicable to the personal usage would be deductible (except for real estate taxes and mortgage interest, which would be reportable on Schedule A).
For this reason, it is essential to set the rent at a fair rate when renting to a relative. Review the amount of rent paid for “comparable rentals” in the area and whether there are additional circumstances in which you are helping your family member (you made any concessions to help pay the rent) which could change the arrangement from a rental activity to a personal use activity.
Contact your Wegner CPAs’ tax advisor if you have any questions or would like to discuss any of these matters in more detail.