Rental Property for relatives • Tax Implications

If you have more than one property, you may want to rent one of them to your relatives, such as your daughter, son, cousin, parents, or others. You may charge them at a discounted rental rate because you don’t want to charge an expensive rental rate.

However, you need to be aware of some tax consequences. In some cases, your property may be reclassified from the rental property into the personal residence. When this situation occurs, the IRS will disallow thousands of dollars in your rental expense deduction.


Rental Property

Under the 26 US Code 280A, the rental property must be rented throughout the tax year. It should never be used by the owner for personal use for more than 14 days or 10% of the total amount of days when the unit is rented at fair market value.

When your property can be qualified as the rental property, deductible expenses can include real estate taxes, utilities, mortgage interest, maintenance, depreciation, homeowner association cost, landscape maintenance, etc.

When the property loses its status as the rental property, all of those deductible expenses will disappear. Your property can lose its status in situations like:

  • Reduced rent. When you rent your relatives your property at a rate that is below the fair market value. 
  • Gifts to help them pay the rent. Your relatives can rent your property at a fair market value, but you give large gifts to them for covering the rental cost. 
  • The property is only rented for a few months, instead of the full year of the rental term. 
See also  Non-Compete and Non-Disclosure Agreements

Don’t lose the rental property status

It is very important for you to maintain the rental property status, so you can get a lot of tax benefits. Here are some useful tips that you need to know.

You can avoid the pitfalls of renting your property to relatives and turning your rental property to personal residence status.

1. Rent at the fair market value

This is the most important thing that you need to do. You are allowed to use your property personally for less than 14 days. If you rent the property to your relatives at the below-market price for longer than 14 days, your property will be pushed out from the rental property status.

You will lose all of the deductible expenses from the rental property. You can check on some other resources for finding the fair market value around you, for example, online listings, forums, etc.

2. Get ready to prove that the rent is fair

You also want to gather and keep all documents that are related to your property, so you can prove that the rent is made at fair market value. You can print and scan all information from similar listings with similar rents in your location.

If you cannot find any other listings, you can also get an independent appraisal for giving the right value to your rented property.

READ MORE: What is a Room Rental Agreement and How does it Work?

3. Your relatives need to use your property as their primary residences

When you rent your property to your relatives, they need to use it as their primary residence. If they only stay in the house for about 3 months out of the full year, you are going to lose the status immediately; they need to stay in the property for at least a year.

See also  Adding New Members to Your LLC Operating Agreement

4. Don’t subsidize them through “Gifts” 

This is another important thing that you need to know, especially when you want to rent your property. Once you set the right rental value for your property, you should never turn around by giving your relatives gifts to help them pay your rent.

The IRS will deduct the gift from the rent price. If the rent price is below the fair market value,  your rental property classification will be transformed into the personal residence classification.