Can my father declare on his taxes the income from renting out 2 rooms in a house (in which we both live), if he transfers the house to me? Or will I be required to report this income?

[js1_]

My widowed elderly father and I are currently living together in his house. He isn't doing too well healthwise.

Given our financial situation due to coronavirus and some other factors, we both agreed that we need to rent out two rooms. We will both continue to live in the house, alongside the 2 new room renters. He is the sole owner of the house (only his name is on title), and only his name is on the mortgage loan.

For specific reasons well beyond the scope of this question he would like to transfer the house to me soon, instead of letting it pass through inheritance/his revocable living trust. 

After the transfer, I will be in the unusual situation where my father's name is the only one on the loan, and my name will be the only one on the title. I will not be assuming the loan.

Some background (not sure how much of this is relevant):
-The house is his principal residence. Neither of us owns any other real property. We’re in California.

-We did some Medi-Cal planning, and structured our bank accounts and finances so that he will be eligible. I do not pay rent.

-It is our understanding this house transfer (his principal residence) should be exempt from CA’s current 2.5yr lookback.

-We both understand his cost basis will transfer to me (versus inheriting at FMV on date of his death). Because he received a step-up in cost basis when my mother recently passed away on both her half and his own half (double step-up), this isn’t really an issue. The house value/cost basis probably would not be much higher if we waited until inheritance.

-The Garn St. Germain Act permits transfer of a house, parent to child, without the loan being called. The lender is legally forbidden to do this in these types of transfers.

-Just to reiterate : The house must be transferred soon, and not inherited, unfortunately. This is not something we are doing without proper legal counsel, or are doing on an uniformed whim.

-The rent checks will all be made out to him. He will pay the mortgage loan (which is in his name) with them and keep the rest.

-(Property tax and homeowner’s insurance will be switched to my name. The mortgage payments include the monthly escrow payments for these.)

-All utility bills are in his name. He will collect the renter’s portions of the utility bills, and pay these bills himself electronically through his bank account.

All of this would be fine, except that now we are both concerned that I would have to declare all the rent income that he collects for himself (to keep and to pay the mortgage, which is in his name), on my tax return instead of his. Without going into detail, financially overall, it turns out this would actually be a big negative, and would affect my health insurance coverage (Covered CA), among other things.

I’ve read through some posts describing situations where non-owners of homes claimed rental income as their own, and advice saying this can be done sometimes, but none of them exactly matched our situation.

My question is, even though I will have sole title to the house, will my father be able to declare the rooms' rent income on his tax return? Does the IRS let us decide who declares it in this situation? Or will I be required by law to take this income as my own? Again - the renters will pay him only, and he will deposit the money into his account to keep and to pay the mortgage (which is in his name only).

We both are okay with not taking any deductions associated with renting the rooms if this will permit him to declare all the rent income on his taxes, although it would be nice if some deductions would still be available.

Thank you.

[Anonymous · Accepted solution]

you can't rent what you don't own. so if your name goes on the title and his comes off, it's your rent. I would recommend that you even pay the mortgage.  even though you are not on the mortgage you would be entitled to deduct the mortgage interest. this would be pursuant to IRS reg 1.163-1 (taxpayers can deduct interest paid on the mortgage if they are the legal or equitable owners of the mortgaged real estate, even if they are not directly liable on the debt).  Also pay the utilities.. this way you report the rental income a a prorata of all expenses on schedule E. you also claim depreciation based on the low of your dad's basis or FMV on date of transfer. you would report on schedule E all the rent and a pro-rata of all expenses (assuming you pay them ) based on square footage rented to square footage of the house.  

your father would have to file a gift tax return because the FMV of the property is greater than the annual exclusion.   also inform your insurance agent about what you are doing.  

[TomD8]

And be sure to inform the mortgage lender of the change in ownership, even though they can't invoke a due-on-sale clause.  And be sure to inform the insurance carrier not only of the change in ownership, but of the fact that you intend to begin renting out rooms.

[Opus 17]

You need to stop posting on this question and adding more wrinkles.  I'm sure we've told you to seek professional advice.  No one on this board will represent you at an audit, or will pay your Dad's medical bills if you guessed wrong on the MediCal lookback rules.

https://ttlc.intuit.com/community/home-loans/discussion/re-if-someone-refinances-their-primary-resid...

Generally speaking, the rental income belongs to the owner.  Period.  If you are the owner, you get the income.

Be aware that if your father gifts you the house, he also gifts you his cost basis.  This is significantly worse for you than if you were to inherit it, especially with California taxes on capital gains.  Also, when you place the property in service as a rental, the basis for rental depreciation is the current fair market value or your cost basis, whichever is lower.  So the gifting strategy may seriously affect your rental income. 

Then, you will be getting in bed with a renter.  Are you prepared to deal with the laws as regards to tenants' rights, discrimination, and so on?  What if the renter doesn't pay?  What if they trash the place?  Do you know your rights and are you prepared to add full time landlord and maintenance man to your other responsibilities?

You need to see an Elder law specialist for your estate and tax planning needs.  Tell them what you want to do (keep the house, avoid the Medi-cal lookback, and generate a little income) and let them tell you how best to do that.

[js1_]

@Opus 17 

Hi Opus,

> Generally speaking, the rental income belongs to the owner. Period. If you are the owner, you get the income.

Thank you. This is what I was looking for. After several hours of searching and reading, some of the posts on this forum seemed to hint or suggest otherwise, which seemed a little odd. Some of them were slightly different situations, so I wanted to give my exact situation to get a more definitive answer (instead of trying to post in those questions).

> Be aware that if your father gifts you the house, he also gifts you his cost basis. This is significantly worse for you than if you were to inherit it, especially with California taxes on capital gains.

All good points. As mentioned in the original post, we are in fact already aware of this. My father’s cost basis received a double step up (for both his portion and my mother’s when she recently passed), so the difference between the cost basis on the transfer versus inheritance will be pretty small.

> Also, when you place the property in service as a rental, the basis for rental depreciation is the current fair market value or your cost basis, whichever is lower. So the gifting strategy may seriously affect your rental income.

Because the cost basis will be high, we’re fine with this.

> Then, you will be getting in bed with a renter. Are you prepared to deal with the laws as regards to tenants' rights, discrimination, and so on? What if the renter doesn't pay? What if they trash the place? Do you know your rights and are you prepared to add full time landlord and maintenance man to your other responsibilities?

Without going into detail, I was a live-in landlord ~15 years ago in another house that was jointly owned. As you’re mentioning, it's nothing to do half-heartedly or to take lightly.

I wasn’t involved much with doing the taxes myself back then (we used a CPA who did almost everything), so one thing I am having to get up to speed on are all the relevant tax laws/deductions associated with us renting these rooms out.

> You need to see an Elder law specialist for your estate and tax planning needs. Tell them what you want to do (keep the house, avoid the Medi-cal lookback, and generate a little income) and let them tell you how best to do that.

Older post/question you referenced: 
https://ttlc.intuit.com/community/home-loans/discussion/re-if-someone-refina[product key removed]ry-...
“Level 15 Opus 17 Level 15 ‎September 8, 2020 9:43 AM
‘xmasbaby0 wrote:
I will add that you should also consult an elder care attorney about the wisdom of gifting the house to you. If your father --who you say is in poor health-- ends up needing Medicaid and going into a nursing home at some point, Medicaid has a five year clawback on "gifts" given by your father. It would be a good idea to do some serious estate planning.’

This is critical. See an Elder Law specialist for your estate planning needs. When a parent "gifts" a house to a child, there can be several very bad outcomes, regardless of whether you can make the gift without screwing up your mortgage. (You could be required to pay up to half or more of the value of the gift back to your father to pay for his medical care, which might force you to sell the house or refinance.)

Besides losing the house to Medicaid, the child can be hit with capital gains tax when selling the house, that can be avoided if proper steps are taken in advance. “

This is all of course good advice and are important cautions for anyone reading.

Just to clarify, we were already aware of all of this, and we already had been in, and are in contact with an estate planning attorney about these things. According to her, it seems we’re good on the long term Medi-cal planning, the house transfer, etc. (although we are still ironing out a few things). I mentioned “This is not something we are doing without proper legal counsel, or are doing on an uniformed whim” in my post to try to preempt these concerns, but in the future perhaps I’ll explicitly state we are in contact with an estate attorney about everything when relevant.

My background is in computer science and engineering, not finance or law. I don’t think most people realize how complicated the getting close to the end of life situation can be until they or a family member experiences it - and then it’s almost as if everyone is taking a crash course.

There is a small possibility we may put the house in an irrevocable trust instead of going ahead with this transfer. (We may ask a related tax question or two about this, if our attorney doesn’t know. She’s expensive, and she doesn’t seem to know as much about some of the specific tax implications of doing certain things, as many of the posters here I’ve discovered.) [edit: such as being a landlord]

So to summarize, we have legal counsel (estate attorney), and we may just need help here and there on some specific questions that our attorney doesn’t know mostly related to taxes. We are not looking for any guidance about Medi-Cal estate recovery, eligibility, or similar things, etc. We also of course understand any advice given is in no way actual tax (or legal) advice, and should be properly vetted.

Also, thanks for your help and input, in this, and also in past questions. I know you don’t have to take the time, so I just wanted to say that it’s appreciated.

[Edited 11.11.2020 | 9:08pm, mostly removed some personal information]

[js1_]

@TomD8 

Yes, that’s a good point about informing the lender when using Garn St. Germain that few mention. We were planning on probably having our estate planning attorney write them a letter.

Also, yes, we will be informing the insurance company about both changes.

[tagteam]

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@js1_ wrote:

.....So to summarize, we have legal counsel (estate attorney), and we may just need help here and there on some specific questions that our attorney doesn’t know mostly related to taxes....

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@js1_ 

No disrespect intended but your estate planning attorney should know virtually everything there is to know that is related to the tax (income and estate) ramifications of the actions she suggests or takes.

If not, she can (or should) engage co-counsel (or a tax professional). Otherwise, it is time to consult with a different estate planning attorney.

[js1_]

@tagteam 

Thanks.

She seems to be well informed in certain areas of tax law, along with property tax, reassessment, CA prop 58 transfers, Medi-Cal, that pertain directly to what she does, but not so much in others, such as rental income or deductions. I don't expect her to be an expert on the rental property side of things. She basically just says she doesn't know/can't comment on it.

I will say, she's expensive, and tends to want to setup a full "appointment" to talk about even just a few small questions, which IMO is a little much. In general, I'd prefer to learn as much as I can about certain topics on my own time before speaking with her, to make the most of things. (And also, just to clarify: For this and the previous question where the house transfer was mentioned - we already had definitive answers from her about Medi-Cal lookback, estate recovery, planning, the Garn St. Germain Act's applicability, Prop 58, cost basis, property tax, etc. - all of these things.)

From what I can tell, we're about 70-80% done with her and everything regarding the planning, and she already understands the situation and our living trust well (she was recommended to us by the attorney who wrote our trust when she retired), so changing attorneys would be counter-productive at this point. She's been pretty good for the most part, apart from the cost. I appreciate the input and comments though.