The Tax Implications of Renting to a Relative

Posted by Lee Reams Sr. on

When a taxpayer rents a home to a relative for long-term use as a principal residence, the tax treatment of the rental depends upon whether the property is rented at fair rental value or rented at less than the fair rental value.

A fair rental is determined based upon facts and circumstances and by taking into account such factors as comparable rentals in the area.

Rented at Fair Rental Value – Where the home is rented to the relative at a fair rental value, it is treated as an ordinary rental reported on Schedule E, and losses are allowed subject to the normal passive loss limitations.

Rented at Less Than Fair Rental Value – When a home is rented at less than the fair rental value, it is treated as being used personally (Reg Sec 1.280A-1(e)(2)).  Since it is rental property which the taxpayer is treated as using personally, the taxpayer would have to allocate the expenses between the personal and rental portions of the year.

However, since all of the rental days (at a bargain rate to a relative) are treated as personal days, the rental portion is zero. So none of the expenses are deductible, other than property taxes and mortgage interest, assuming the interest would otherwise qualify as second home mortgage interest.

Since it is not a rental, the income would be reported as “other income” (line 21 of the 1040) and the mortgage interest and taxes deducted on Schedule A, assuming the landlord is itemizing deductions.

There also could be a gift tax issue depending upon the difference between the fair rental value and rent actually charged to the tenant-relative.  Of course that amount would be pro rated to each occupant of the home, so unless there was a large difference ($14,000 per each occupant, in 2016) between the fair rental value and actual rent, or other gifting was involved, a gift tax return probably isn’t needed in most cases.