This is most likely way to complex to be handling one's self, and especially in this pubic forum. You should probably seek professional help with this. Especially if your state taxes personal income.
My wife and I put up half the money, while our son put up the other half.
That means your son has 50% ownership of the property, and you and your spouse each have 25% ownership. With your son being 50% owner and assuming both units are the same size, an owner can't pay rent to live in that which they own. I see several ways to look at it, and I don't know what's considered "legal" by any stretch.
1. What you call "rent" from your son, is your son''s share of the mortgage payment, to which he is entitled to claim and deduct an equivalent share of the interest paid on the mortgage.
2. What you call "below market value" on what he pays, is not below market value. Since he manages the property, he gets paid $250 a month to manage your share of the property. Therefore, he's paying the same rent as the other unrelated tenant, but is being paid $250/mo to manage your share of the property. That $250 would need to be reported as income by your son on SCH C, in his self-employed position as your property manager for your share.
Since there are three owners, if this isn't being reported as a partnership on a 1065 Partnership Tax Return, the complexities are deep. Things get even deeper if any one of the three owners sells, as the son who lives in one unit as their primary residence will be eligible for the "2 of last 5" capital gains tax exclusion on any gains he realizes on the sale, if the unit is his primary residence for at least 2 years. You and your wife will not qualify for this exclusion, since it seems apparent you don't live in any unit, and probably have no intentions of doing so.
Please seek professional help with this, yesterday if not sooner.
