Picture this scenario.
You buy a second home for investment purposes and rent it out to a parent, sibling, or child. On the surface, this might seem to be a good deal. You’re helping out a family member, knowing that individual will take good care of the house.
But do you have to report rental income from that family member to the IRS?
The simple answer is that the IRS states that rental income is taxable, so yes, you must report rental income. But as with many tax issues, there are multiple answers to this question, based on the following.
Length of Time
If that family member uses that home for more than 14 days or 10% of the total days rented (whichever is higher), you don’t have to report the rental income. The IRS considers the property for personal use rather than investment purposes.
That’s the good news. The not-so-good news is that you also can’t deduct rental expenses. In this case, the only expenses you can deduct are mortgage interest and depreciation, similar to what you’d deduct if the home were your primary residence.
What You’re Charging
Giving your family a discount on the rent might seem to be a nice thing to do. Giving that discount also signals to the IRS that the home is for personal use. You don’t have to report that income. But remember that not renting that property at the fair market value means you lose rental expense deductions.
However, maybe you decide to have your cake and eat it, too. You charge your family member the fair market value, then subsidize the rent through a monetary gift. The IRS will see right through this and could classify that home as a personal residence.
The Profit Motivation
Perhaps you’ve decided that you’re not interested in earning a profit from the rental activity on that home and choose to charge below-market rent. If the family member uses that property as their primary home, you could consider it a not-for-profit rental.
In this scenario, you would still need to report the rental income. You could also deduct expenses – but only up to the amount of the rental income received. You aren’t allowed to claim a loss.
Weighing What’s Best
When renting your property to a family member, you must determine if you want to be nice and charge below the market rent or deduct expenses from the rental income. Sometimes, you don’t have to report rental income from a family member. But deciding on this path means you might be unable to take certain deductions. Given the multiple answers to the question about reporting rental income, discussing the situation with a professional advisor familiar with the regulations is a good idea.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
