Baby boomers are caring for more people than any generation before them. It is not uncommon to hear of a middle aged couple helping out elderly parents, children, and even grandchildren. In many cases, this help includes renting to a relative. The assumption is that people can rent to relatives and get certain tax breaks available to land owners. However, there are a few special IRS laws that may leave people who take this route at risk of an audit and fines.
What Qualifies as a Rental Property?
One common mistake is that people try to claim rental expenses for homes that are not technically rental properties by IRS regulations. In order to be a rental property, a property must be used by the owner less than 14 days per year or 10% of the time it was rented at a fair market value. If a home meets these qualifications, homeowners can write off a variety of expenses such as taxes, mortgage interest, maintenance, and utilities. Many homeowners manage to generate a loss on paper and offset other taxes, which can make renting to a relative at a cut rate seem like a good fiscal decision.
Fair Market Value Is Key
One sure way to red flag your tax return is to rent a home to another person at less than fair market value. If this is not the case, none of the home expenses are deductible. There are actually more write offs if you allow the relative to live in the home without paying rent at all, although this could create interesting situations with gift taxes.
While it is generous to allow a relative to live in one of your properties at a less than prime rent, you cannot use tax write-offs to make up the difference. The IRS is becoming increasingly adept at identifying and red flagging this item, so it will pay to stay well on the right side of the law.
