Here are some things to consider when renting to a relative:
Make sure that you are renting at fair market value.
It is important to charge fair market value to assure that you can claim all of your rental expense deductions. If you rent below fair market value, then every day the relative rents the property is considered the same as a day when the taxpayer personally used the property.
Property cannot be considered rental property if the owner uses it personally for more than 14 days. So, if the taxpayer rents to a relative at below market value for longer than that, the house will be pushed out of the rental property classification, and the owner will lose all deductible expenses except mortgage interest and real estate taxes.
Be Prepared to Prove the Rent is Fair
You need to gather and keep proof that the rent is at fair market value. Some ways to do this are to
- Print or scan information about similar listings with similar rents
- Get fair rent letters from property managers
- Get an independent appraisal
The Relative Should Use the Property as Their Primary Residence
If the taxpayer wants the property to be considered rental property for tax purposes and they rent it to a relative for the year, that relative must use it as a primary residence. Otherwise, just as with renting at a below market price, every day the relative spends in the house will be considered a personal use day for the owner. So, if the relative just stays in the house for three months out of the year but has their principal residence elsewhere, that will kick the property right out of the rental property classification.
Be Cautious About Using a “Good Tenant” Discount
You may be able to give their relative a small price break by using what is known as a “good tenant discount”. Although 20 percent has been allowed in the past, that’s not a shoo-in. It’s safer and easier to defend a 10 percent discount.
5. Don’t Subsidize the Rent through “Gifts”
Once you set a fair market value for the rent to the related party, don’t then turn around and give them money gifts to help them pay the rent. The IRS may deduct the gift amounts from the fair market value rent price, and once again, a rental property classification could be quickly transformed to a personal residence classification.
For more on this topic see IRS Publication 5I27 - Residential Rental Property.
@ marcjy
