Proper Way to Report Rental Gains / Losses

[BobFowkes]

I've seen examples that ALMOST mirror ours, but not quite.  So here goes.

We bought a two-family in Boston with our son. My wife and I put up half the money, while our son put up the other half. We started with $105K each but both parties have added another $5k. Now it seems to be generating enough income to cover expenses.

The son lives in unit 1 with his fiancee.  They pay rent, about $250/month less than the market rate because he is the on-site landlord and deals with most issues that come up.

A family lives in Unit 2 and pays market rent.

So how do we figure the taxes, for (1) My wife and I, and (2) for my son? (It so happens that I do the taxes for him and us.)

For my wife and I, would we report the whole building on schedule E, all the rent, all the expenses and depreciation? Then take 50% of the gain/loss on our return?

For my son, does he report just the numbers for Unit 2 on his schedule E, the rent and the allocated expenses? Then take 50%?

Any insight would be appreciated.

[AmyC]

Either you mean you own half the house, unit 2 or you mean you own half of the whole house. Let's look at this.

If your son bought unit 1, he just bought a house and its out of this equation.

If you all own the whole house, this will get messy. I am guessing the units are different sizes if you both own the whole unit. This is a relative living in the house for below rent, that is managing the complex, and an owner.

Unit 1 is for the personal use of the owners. Nobody is renting unit 1. Owners don't rent their own house. You don't buy a house, get a mortgage and then pay rent to someone else. 

Unit 2 - this is all that is left for you to co-own. Add up rent and expenses and divide by your share. 

So, for simplicity, let's say unit 2 is twice the size of unit 1. Then your son owns his whole unit plus 1/3 of unit 2 while you own 2/3 of unit 2.

[Carl]

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.

[BobFowkes]

Appreciate the answer, Amy.

My son owns half of the whole property, not Unit 1 where he lives with his finacee. It may be simpler to view the two units as condos and he owns unit 1 and my wife and I own unit 2, but that is not the reality.

My son pays "rent", or rather the couple pays rent. But that's just what we call it. He could write a check every month for half of the mortgage, half the utilities, half the insurance, half the taxes, and half the other stuff. That would be several hundred more per month that what he pays, or rather, what he contributes to the bank account for the property.

Just FYI, the two units are almost exactly the same size. Before we bought it the previous owner charged about the same for each unit.

So I guess what I should do is:

1. Ignore Unit 1 on his return.

2. Populate schedule E for only Unit 2 rent, expenses and depreciation.

Sound right?

[BobFowkes]

Appreciate the answer Carl.  See my response to Amy.

When we do sell the place I will definitely get some tax help on the best way to handle the capital gains, for him and for us.

Thanks.