Market increase caused FMV to increase do I have to increase rent

[Rob1235]

I'm renting a house to my son, but due to a market explosion the FMV has increase from $1760 to $2400 per month, in less than a year.  This will probably price him out of the home.  Will a lease protect the lower rate or do I have to raise the rent inorder to keep the associated tax deductions.  Does anyone know what tax deductions I will lose if I continue rent below FMV and put the property into the personal use category.

Thanks in advance.

[tagteam]

Every day you rent your rental real estate below fair rental value to any individual is considered to be a day of personal use, per Section 280A.

As a result, you would lose all of the typical rental deductions with the exception of mortgage interest and property taxes, both of which would have to be reported on Schedule A (not Schedule E).

[Rob1235]

Thanks for the info, but does FMV have a a  range...  If that reference is that strict, I should have been raising his rent every week regardless of the lease or its becomes personal use.  Also,  when I read the reference you sited is talks about the FMV at the time the lease is initiated.    So this tells me I don't need to adjust the rent until the lease is up and when I renew the lease it needs to be adjusted to fair markety value at that time.  Am I reading this corectly?  The FMV is preserved until the lease expires?  Thanks in advance 🙂 

[Opus 17]

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@Rob1235 wrote:

Thanks for the info, but does FMV have a a  range...  If that reference is that strict, I should have been raising his rent every week regardless of the lease or its becomes personal use.  Also,  when I read the reference you sited is talks about the FMV at the time the lease is initiated.    So this tells me I don't need to adjust the rent until the lease is up and when I renew the lease it needs to be adjusted to fair markety value at that time.  Am I reading this corectly?  The FMV is preserved until the lease expires?  Thanks in advance 🙂 

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Do you have a signed lease with a fixed rent and definite end point?  In that case, you will re-determine the FMV when the lease is renewed.  If you don't have a signed lease, then you probably have a month-to-month tenancy under state law, and that would mean you have to adjust the rent every month.

There is no prohibition against renting to family at below FMV.  What happens is, you lose the ability to deduct expenses if they are more than your rent, so the rental becomes less profitable, but do you really want to make a profit from family?

For example, if your expenses are $1600, then you can only deduct $1600 of expenses no matter whether you charge $1700 or $2400, so adjusting the rent to FMV will not change your taxable income or deductions.  If your expenses are $2800 and you rent at $1700, you can deduct up to $1700 of expenses and you lose the rest of the deduction.  If you rent at FMV, you can deduct the entire amount of expenses.

Bottom line, sometimes (but not always) renting at FMV will allow you to show a deductible loss even though you have positive cash flow.  If you rent below FMV, your expenses are capped at the amount of rent and you can't take a deductible loss.  But there are other reasons to rent to family besides maximizing profit. 

[tagteam]

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@Opus 17 wrote:

There is no prohibition against renting to family at below FMV.  What happens is, you lose the ability to deduct expenses if they are more than your rent......

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That is actually not what happens. Rather, the owner loses the ability to deduct all typical rental expenses for each day of personal use. Essentially, the property is treated in the same manner as a second home during those personal use days.

I.R.C. §280A(d)(2)(C):

(2) For purposes of this section, the taxpayer shall be deemed to have used a dwelling unit for personal purposes for a day if, for any part of such day, the unit is used—

(C) by any individual......, unless for such day the dwelling unit is rented for a rental which, under the facts and circumstances, is fair rental.

Per Section 280A(d)(3)(A), regarding rental to a family member, rental real estate can be reported as a standard rental provided the family member uses the property as a principal residence and pays fair rental.

[AmeliesUncle]

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@Rob1235 wrote:

but does FMV have a a  range...  

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Yes, FMV has a range.  FMV for an existing tenant that is known to be a 'good' renter (such as your son) can be somewhat lower than FMV to an unknown stranger.

If the amount of rent gives you a positive cash flow, then in my opinion FMV is even more flexible.

You also said that "FMV has increase from $1760 to $2400 per month, in less than a year".  Again, in my opinion, that gives FMV more flexibility and can reasonably be closer to the previous year's FMV.

[Opus 17]

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@tagteam wrote:

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@Opus 17 wrote:

There is no prohibition against renting to family at below FMV.  What happens is, you lose the ability to deduct expenses if they are more than your rent......

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Per Section 280A(d)(3)(A), regarding rental to a family member, rental real estate can be reported as a standard rental provided the family member uses the property as a principal residence and pays fair rental.

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My understanding on renting real estate below FMV has been that you can deduct expenses up to income but not more than income.  I could be wrong.  I've gotten most of my real estate information from @Carl over the years. 

[tagteam]

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@Opus 17 wrote:
My understanding on renting real estate below FMV has been that you can deduct expenses up to income but not more than income.  I could be wrong.  I've gotten most of my real estate information from @Carl over the years. 

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I understand but your understanding is not correct according to the Code and Regulations (which Carl, apparently, either has never read or, if so, does not comprehend).

The limitation to which you are referring would apply to not-for profit rentals and to vacation rentals where there is more than the specified amount (in the Code) of personal use.

[tagteam]

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@AmeliesUncle wrote:\
Yes, FMV has a range.  FMV for an existing tenant that is known to be a 'good' renter (such as your son) can be somewhat lower than FMV to an unknown stranger.

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I agree, but the range is not unlimited. For example, I have my doubts as to whether a "good renter discount" would justify a discount in excess of 25%.

On the other hand, I believe the length of the term would be relevant; a longer term would appear to support a larger "discount" from FRV. Here, if the son had an agreement to lease the property for a 5-year term, one could argue for a greater discount.

Regardless, what constitutes a fair rental price, and the various criteria, is set forth in the IRS publication at the link below.

https://www.irs.gov/publications/p527#en_US_2020_publink1000285445

[Carl]

I'm not sure if the program does it or not, but I would expect it to.

When you indicate that you are renting below FMV you still enter all of your rental expenses, even if they exceed the rental income. The program (I think) will only deduct the amount of expenses up to the rental income received, and the excess expense is not carried over. It's just lost forever.

My thing is what *exactly* defines Farm Market Rental Value? There is no magic formula that I can find. The best definition I can come up with is this.

FMRV is any value that is between the highest amount the renter is willing to pay, and the lowest amount the landlord is willing to accept. Generally, the rent amount will be on par with other rentals in the given area that are of the same size, condition, and offer the same or equal value amenities.

So take two rental properties that are both 1500 sq ft with 2BR/1BA. One was build in 2018 out of concrete block, the other was built in 1940 out of wood. I would expect the newer house which is of better construction to rent significantly higher than the older house with it's 15 year old appliances and window A/C units in it, instead of central air.

[tagteam]

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@Carl wrote:

The best definition I can come up with is this.

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You do not have to guess at this nor formulate a definition since it is set forth in an IRS publication:

Fair rental price.

A fair rental price for your property is generally the amount of rent that a person who isn’t related to you would be willing to pay. The rent you charge isn’t a fair rental price if it is substantially less than the rents charged for other properties that are similar to your property in your area.

See Publication 527 (2020), Residential Rental Property | Internal Revenue Service (irs.gov)

[The passage in italics above is also in the TurboTax guidance]

[tagteam]

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@Carl wrote:

When you indicate that you are renting below FMV you still enter all of your rental expenses, even if they exceed the rental income. The program (I think) will only deduct the amount of expenses up to the rental income received, and the excess expense is not carried over. It's just lost forever.

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That would be wrong if the program, in fact, handles the scenario described in that manner. 

It does not do so, however, because it asks for the number of fair rental days and the number of personal use days. If those fields are entered accurately by the user (e.g., no fair rental days), the program will kick it out of Schedule E treatment.

Regardless of how this scenario is handled by TurboTax, the Code (Section 280A) mandates that each day rented at below fair rental value is considered to be a day of personal use (that means the owner is limited to Schedule A treatment for mortgage interest and property taxes and can deduct none of the typical rental expenses).

[TomD8]

I think @tagteam 's summary is correct.  From US Code 280A:

(2)Personal use of unit: For purposes of this section, the taxpayer shall be deemed to have used a dwelling unit for personal purposes for a day if, for any part of such day, the unit is used—

(A)

for personal purposes by the taxpayer or any other person who has an interest in such unit, or by any member of the family (as defined in section 267(c)(4)) of the taxpayer or such other person.

26 U.S. Code § 280A - Disallowance of certain expenses in connection with business use of home, rent...

Also, this HUD website allows you to look up fair market rents by zip code:

https://www.huduser.gov/portal/datasets/fmr.html#2022

[tagteam]

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@TomD8 wrote:

(2)Personal use of unit: For purposes of this section, the taxpayer shall be deemed to have used a dwelling unit for personal purposes for a day if, for any part of such day, the unit is used—

(A)

for personal purposes by the taxpayer or any other person who has an interest in such unit, or by any member of the family (as defined in section 267(c)(4)) of the taxpayer or such other person.

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Yes. There is an exception to the above-quoted section in 280A(d)(3)(A), but the property must be used by the family member as a principal residence and pay fair rental.

Fair rental is the key without which the real estate is deemed to be for personal use. If the property owner has 365 days of personal use, that property owner essentially just has a second home.

[Opus 17]

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@tagteam wrote:

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@TomD8 wrote:

Fair rental is the key without which the real estate is deemed to be for personal use. If the property owner has 365 days of personal use, that property owner essentially just has a second home.

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I think this only applies to rental to an owner or family member.

It is not personal use if an owner rents below FMV to an unrelated person.  That is where the expense limitation comes from that I was thinking of.  I was incorrect in this situation where the tenant is related to the owner, but I believe I would still be correct in the situation where the tenant was unrelated to the owner, based on the quoted regulatory language.