Taxes and renting "at cost" to a relative

[Knitasaurus]

Background:

My husband and I bought a house last year and decided to rent out the house we already owned to a few friends and my sister while she was a student. We are not really sure if it's something that will give us a good return as a rental over the long term, but it was easier to set up as a rental than to think about putting it on the market at the same time as buying and moving.

We haven't been classifying the income as rental income or claiming any depreciation on the property or anything, we've just been declaring the rent received as miscellaneous income on our taxes. What we collect in rent basically covers the mortgage payment, plus insurance and taxes, and the amount we pay in taxes on that income. So it feels like a wash, although the rent does pay down the principal on the mortgage, which we would theoretically get at some point if we sold the house.

My sister is graduating this spring, and getting married this summer. She has asked about the option of renting the house with her fiancé, which my husband and I are totally willing to consider. I know they would take good care of the property, and it would be easier for us to manage than it is now, with four different people there. If we charge them what we've been collecting from four people ($1100), the property would continue to be more or less financially self-sustaining, but that might not be the best option for them (they could find an apartment that would be adequate for the two of them for less).

What we've been wondering is--is there any way we could set it up so they just pay the mortgage/taxes/interest ($750) so we wouldn't have to declare that as income? We would have to work something out for maintenance costs, of course. And we're willing to do some paperwork if that's required. It would be a win for them because they'd have a nice place to live that's close to work and the library and parks, etc, for a comparable cost of renting an apartment. It would be a win for us because we wouldn't have to do as much to tend the property, and the mortgage principal would continue to get paid down.

Has anyone else ever done anything like this?

[lizzzi]

Ditto the same question. I paid cash for a house around the corner, so no mortgage, but our daughter, son-in-law, and three grands live there and pay all taxes, insurance, maintenance, all bills, etc. This just started at the end of 2013, so I'm wondering how it will affect my federal tax return. If I treat it as a "rental property", they are only paying around $200--250 per month in this low cost-of-living area.  That is nowhere near market rent, which would be probably $1200. I will talk to my tax man of course, but would appreciate any wise counsel from Mustachians. (I'm not foolishly generous-- they help me with a boatload of "nurse's aide" work, helping take care of a very elderly, frail grandpa who does not want to go to a nursing home.) Family helps family, like in the old days--but I don't want to get killed on taxes for it.

[PeachFuzzStacher]

FYI, my wife and I rented a one bedroom from my Gramps for 4 years while we saved up for a house.  He was happy that the costs were covered and the place was being cared for.  If you need to buffer in an extra $100 a month or so to keep up with costs, I'm sure the family tenants would still be grateful.  He raised us $50 half way through because the sewer tax went up.  I didn't care at all - still 300 less than market rate.

[AB]

I have read a few articles on this subject.  If you search ("rent to family") you can find many more.
   http://voices.yahoo.com/can-deduct-expenses-related-renting-property-8311615.html
   http://www.rontaxcpa.com/showtip.php?newsid=139
   http://www.irs.gov/taxtopics/tc414.html    (Rental Income and Expenses)
   http://www.irs.gov/taxtopics/tc415.html   (

I am not an expert, nor giving any advice, but here is my general understanding:  From a tax perspective, it seems the key point is to charge "market rate" for the rent.  If you charge them market rate, then you can deduct your expenses on your tax return... per the IRS, expenses "may include mortgage interest, real estate taxes, casualty losses, maintenance, utilities, insurance, and depreciation, will reduce the amount of rental income that is taxed".  Because of depreciation, your expenses will likely be greater than your rental income.  :)

If they (sister) can't afford market rate, I believe you may have an option whereby you give them a 'gift' (The annual IRS exclusion for gifts remains at $14,000 for 2014 ... http://www.irs.gov/uac/Newsroom/In-2014,-Various-Tax-Benefits-Increase-Due-to-Inflation-Adjustments) which they essentially could then use to pay other expenses (utilities, food, etc), and use their own money to pay the larger rent amount.  Just make sure that they write you a check each month for the rent.   I think I read that it is best to setup a separate bank account for the rental income too ... for more detailed information you should probably speak with your accountant.  Good luck.

[Mori]

From the IRS page:

--
Not Rented for Profit http://www.irs.gov/publications/p527/ch04.html

If you do not rent your property to make a profit, you can deduct your rental expenses only up to the amount of your rental income. You cannot deduct a loss or carry forward to the next year any rental expenses that are more than your rental income for the year.


Expenses: http://www.irs.gov/publications/p527/ch01.html
In most cases, the expenses of renting your property, such as maintenance, insurance, taxes, and interest, can be deducted from your rental income
---

I think that takes care of your issues. When I rented a room to a relative, I used this and put it under the Schedule E (I did a percentage based on rooms in the house and usage). YMMV, so make sure to talk to an accountant. The one I called did a free consult on this issue.

Good luck!

Ashley