What Gift Tax Issues Arise When Renting to a Relative?
Owners of rental property are in a unique tax situation and enjoy many different benefits. One of these is that renting out a home or apartment that you own may result in a tax loss for you, even if the rental income is more than your operating costs. Owners are entitled to a depreciation deduction for your cost of the house or apartment.
Renting a Home to a Relative and Gift Tax issues
However, to prevent abuse of these generous depreciation rules for rental property owners, if your tenant is related to you special rules and limitations may apply. For these purposes “related” means spouse, child or grandchild, parent or grandparent, and siblings.
First, if you rent a home to a relative who:
- Uses it as his or her principal residence (that is, not just as a second or vacation home) for the year, and
- It’s rented at a fair rental (not at a discount), then no limitations apply.
You can deduct all the normal rental expenses, even if they result in a rental loss for the year.
Renting to Relative Below Fair Market Value
The tax problem arises if the rent on the dwelling to the related party is below the fair rental value. Since this then becomes a rental property which you are treated as using personally, you would have to allocate the expenses between the personal and rental portions of the year. Even more seriously, if all of the rental days that are given at bargain rate to a relative are treated as personal days, the rental portion is zero. Thus, you would have to report all of the rent you receive in income, but none of your expenses for the home would be deductible.
Setting Rent at a Fair Rate
It is important to set the rent at a fair rate. Factors to look at include comparable rentals in the area and whether “side” gifts were made by you to your relative which could be reasonably interpreted to be the bargain element.