By: Tamara Pow
Many people are very fortunate here in the San Francisco Bay Area to have acquired so much wealth in their real estate, both their homes and their vacation homes, as well as homes held for investment. As a result, I am often asked to assist my business and real estate clients with a personal matter – leasing a home to a family member.
Leasing a residence to a family member can be hazardous in many ways.
Before you do so, you should think carefully about whether you would be willing to enforce the lease or sue your relative if they do not perform under the lease. Think about evicting your family member… then think about what Thanksgiving will be like next year. However, there is also a tax issue to think about – renting to a family member may mean that you cannot take any tax deductions for losses on the property.
The general rule is that if you receive rental income for the use of a dwelling unit, such as a house or an apartment, you may deduct certain expenses such as mortgage interest, real estate taxes, casualty losses, maintenance, utilities, insurance, and depreciation. These expenses will reduce the amount of rental income that is subject to tax, usually providing tax losses for you as well (subject to certain limitations). However, this is only available if you are renting to make a profit and not if you are using the house as a personal residence.
The IRS says you are using a house as a personal residence if you use it for personal purposes during the tax year for more than the greater of 14 days or 10% of the total days you rent it to others at a fair market rent. You are considered to be using a house if a member of your family is using it, unless they pay fair market rent. A recent tax memo confirms the IRS is enforcing this rule. In Okonkwo (TC Memo, 2015-181), the parents rented out a house to their daughter for $2,000 per month, much lower than the $6,000 fair market rent they had received previously. They deducted the mortgage interest and depreciation. The Tax Court held that the losses are not deductible because the tenant is a family member paying below market rent, so her use is treated as use by the owners, her parents. Because her parents are considered to use the property for more than 14 days or 10% of the total days rented to others, they get no rental loss deductions.
Here are some other special rules you should be aware of:
If you use a house for both rental and personal purposes, you have to divide your expenses based on the amount of rental use and the amount of personal use. Your loss deductions will be limited to the rental income, but you may be able to carry forward some losses to the next year. You may still be able to deduct the personal use portion of expenses such as mortgage interest, and property taxes.
If you rent your personal residence for fewer than 15 days, you do not have to report any of the rental income (and you do not get to deduct any expenses as rental expenses).
The Kiplinger Tax Letter, Vol. 90, No. 20, September 25, 2015.
The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.