Do I charge my mom rent for a house I co-own?

[sweens]

Hi - My mom currently lives in a house owned by her two brothers, where she pays them $1,100/month rent. This amount is close to FMV for a room rental in the area -- she's the only one who lives in the house, but the other rooms are reserved for when family visits. Her brothers pay water and utilities. I am purchasing half of the interest in the house (by buying out one of her brothers who wants to sell). It will be an all-cash buyout at fair market value. My share of property taxes will be about $7k/year. This will be the only property I own, and I do not intend live there. Is it better to have her continue to pay $1,100 rent so I can claim this as a rental property (where we pay for utilities and water) or can I let her live there rent-free on my end (she would still pay her brother $550/mo.)?  Any input would be greatly appreciated. This is all new to me. Thank you.

[RobertG · Accepted solution]

You can let her live there rent free without any tax consequence. 

You would be able to claim your portion of interest and taxes as if it was a second home.

If you were paid rent and reported it as a rental, you probably should not claim any losses from it, since you can't claim losses on property rented at less than fair market value to a relative.

You would only be able to claim expenses for the room, in any case, because the rest of the house is reserved for personal use.

[Anonymous]

you are not renting at FMV.    if taxes are $14,000 a year but rent is only  $13,200  there is something different about your property than others in the area.    The $13,200 does even include other out of pocket items like repairs, mortgage payments, etc.   $it seems $1,100 is room rental rather than house rental which is what you mon is doing.   the IRS does not allow you to take a rental loss on property rented to relatives at less than FMV 

you may want to reconsider purchasing.     your only deductions would be real estate taxes and mortgage interest on schedule A.  if your taxes such as state income taxes and real estate taxes on your own home already exceed $10,000 you will not get any further benefit from the real estate taxes you pay on mom's house.  if your mortgage on your own house is close to $750,000 or maybe a $1,000,000 the deductibility of the interest on mom's house could be limited. 

[sweens]

@Anonymous  Yes, this is only a room rental which is why rent is low compared to the cost of the house, and I don't own any other property. I'm not looking to make any money of this purchase -- I just want my mom to have a place to live.

@RobertG  - Thanks - super helpful. I'll will consider this second home and not charge my mom rent. 

[Carl]

you are not renting at FMV

I'm not quite in agreement with that statement. If your mom was paying that for the entire house each month, then I would agree that there's no question you are not renting at FMV. However, you specifically stated, "This amount is close to FMV for a room rental in the area... the other rooms are reserved for when family visits. "

Based on that, I agree that $1,100 a month for a *ROOM* in the house could very well be FMV.  Your comment also leads me to think she does not have access to or use of 100% of the floor space in the house either.

For starters, if the two brothers own the property then they have what is called a Partnership. Generally, a partnership files IRS Form 1065 Partnership Return. The partnership then issues each partner a K-1 which each partner needs in order to complete their personal 1040 tax return.

So basically, you are buying out the partnership interest of one of the brothers.

More than likely the two brothers are not filing a 1065 Partnership Return. Instead, they are each reporting their half of the rental income/expenses on SCH E of their individual tax returns, claiming a 50% ownership interest in the property. It's okay to do things that way with rental property. But if any of the partners are married and live in a community property state, it has the potential to create legal issues should the married partner(s) divorce, or separate and file separate returns for whataever reasons.

$1,100/month rent. This amount is close to FMV for a room rental in the area

So as I see it, your mother is not renting a house. She is renting a room. This is why I seriously doubt the two brothers are reporting this as a partnership on the 1065 Partnership Return. Basically the property is not 100% business use. So this further complicates matters.  For example, if the room she is renting occupies 10% of the total floor space in the house, then only 10% of the mortgage insurance, property taxes and property insurance is deductible as a SCH E rental expense. So with two owners of the property that means each owner can only deduct 5% of those expenses on their personal tax return. The remaining 45% (for each partner) is a SCH A itemized deduction.

Additionally, assuming 10% business use that means that only 10% of the utility bills are deductible as a SCH E rental expense, and the remaining 90% isn't deductible anywhere on the tax return at all.

Do I charge my mom rent

So long as the other partner charges rent, then weather you do or not does not change the fact that there's business use here.

As you can see, this *will* get very complicated, very fast. Even more-so if your state taxes personal income. I would *highly* recommend you seek the services of a tax professional in your area before making any commitments here. Then if you decide to buy in to this, you can do so with a plan that will keep you out of trouble with the IRS, and possibly your state taxing authority too.

On a more personal note, and without sticking my nose in your personal business, this is an arrangement I would never agree to myself. Based on my own knowledge of the experience of others, I've found that the one ship that never makes it to port after it sets sail, is a partnership. Especially if there's a blood relation between the partners.

[sweens]

@Carl  - Thank you for such an informative post. I will need to talk to my uncle (single/unmarried) with whom I'll co-own to property to find out how he's filed/filing taxes. There is no mortgage on this house, and my uncles are currently benefiting from Prop 58 in CA, where they pay very low property taxes on the house.

You wrote, "More than likely the two brothers are not filing a 1065 Partnership Return. Instead, they are each reporting their half of the rental income/expenses on SCH E of their individual tax returns, claiming a 50% ownership interest in the property. It's okay to do things that way with rental property. But if any of the partners are married and live in a community property state, it has the potential to create legal issues should the married partner(s) divorce, or separate and file separate returns for whatever reasons." The brother who I'm buying out is married and lives in Washington. The brother with whom I'm co-owning is single/never married. Does this help make things less complicated if they are simply using Schedule E and my uncle who will keep the house is single?

I realize that this may not seem like an ideal set-up, but I think it makes sense for my mother, uncle, and me. The price I'm paying for half of this house is less than the cost of owning a condo in the neighborhood.  Houses go for over 1 mil. This was my grandparent's house, and when my grandmother passed away 3 years ago, her estate passed to her 3 children (my mom and her 2 brothers). My mom disclaimed her inheritance, so it passed to me. The 2 brothers bought my/my mom's share of the house with the intent they'd sell it after about 2 years, which would give her time to figure out another living situation. She's lived in the house for the last 20 years. In the last few months, I found out that one of my uncles (single, unmarried) would prefer to keep the house. He uses it for garage storage and visits every weekend to help with maintenance, etc., and has done so for his entire life. So after finding out that my uncle would prefer to keep the house, and my mom would prefer to keep living in the house, it seems to make the most sense to co-own the property with him. This gives my mom a place to live affordably in Los Angeles, and it's near her work.