Renting home to my parent in exchange with childcare

[ali_r2d2]

Hi,

Can I rent my rental house to my parent in exchange with taking care of my kids? 

Can I still claim the house as a rental and get the tax advantages?

We can also pay them $1500 monthly for the child care then they pay $1500 rent. Will it cause any problem tax wise? They don't have any other income other than a little pension money that they bring from their country and we take care of their grocery. They've never filed for the tax. 

[DanielV01 · Accepted solution]

Can you legally claim this?  Sort of, but it's probably a bad idea to try.  Here's why:

First, of all there's the child care.  If you are paying them $1500/month, then they need to be claiming $1500/month of self-employment income, which will be subject to self-employment tax of around 15% that is only reduced by (legitimate) business deductions.

Next, there is the rental income.  You would have to include $1500 of rental income per month in your income.  Only then could you potentially claim rental expenses.

Third, claiming rental expenses will depend on whether or not you are renting at a fair rental value.  $1500 may well be fair rental value, but you need to compare that amount with other rentals in your area.  If you are renting below fair rental value, then your expenses are not deductible.

Fourth, if the rental is occurring in your home, any expenses are going to be prorated and limited to what is used exclusively for the rental portion.  Any personal-use expenses are not deductible.

Fifth, and perhaps more important:  substantiation.  If somehow you follow all of the above four rules and the tax advantage is greater (very unlikely), then the IRS can ask for substantiation to prove you have a legitimate arrangement.  This could include items such as a rental agreement and other proofs.

All of these tax hoops do not make a claim like this very advantageous.  However, if you are caring for your parents, provide at least 1/2 of the household support, and they have less than $4200 (each) of taxable income in the year, you could claim them as dependents, which would be much simpler, easier to substantiate, and probably a greater overall benefit than what you suggest above.  Here is a link that can assist you with this:  

• Can I claim my parent as a dependent in 2020

And if you claim them as a dependent, it will not be necessary to claim babysitting income paid to them (because they are not receiving money for this), nor rental income to you (because you are caring for them in the home), or any other complicated information.

[AmeliesUncle · Accepted solution]

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@DanielV01 wrote:

All of these tax hoops do not make a claim like this very advantageous.

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Building Social Security credits to qualify for Social Security and Medicare and/or having enough income to qualify for the Premium Tax Credit for Marketplace health insurance (over 100% of the Federal Poverty Level) far outweighs the potential negatives that you have pointed out.   🙂

On the other hand, in my opinion a grandparent watching their grandchildren rarely, if ever, rises to the level of a business.  If that is the case, it would not be subject to Self Employment tax, which would mean Social Security Credits would not be built up.

[ali_r2d2]

Thank you for the detailed response @DanielV01 .

How about this scenario:

They live in the house, we pay the mortgage, we claim them as dependents.

- Will we still get the advantage on the second house mortgage interest and property tax? (Both houses together are $750,000)

- The new house is old and needs some repair and doesn't have washer, dryer and fridge. Can we get claim any of these on the tax?

- After two years, we will remodel the house, sell it and will earn $100K profit. Should we pay tax on this $100K? We're on 24% tax bracket.

[DanielV01 · Accepted solution]

Three separate questions:  

Q1:  Will we still get the advantage on the second house mortgage and property tax?  Yes to mortgage interest, and probably not to property tax.  As long as the property is a second home (no more than 2 houses can be claimed), then you may claim both of these; however, your SALT deductions are capped at $10,000, which includes real estate taxes.  Given that you are in a higher tax bracket, it is likely that you are already over the SALT threshold and likely see no additional benefit.  This Help Article provides additional information:  Can I deduct mortgage interest on a second home?

Q2:  Repairs cannot be claimed for any tax benefits at the time of doing them, provided that the home is "personal use".  However, the money spent can effectively increase the basis (amount invested) in the home, which can assist your taxes when you sell.   For these expenses to have potential deductibility, they must be considered improvements (which increase the value of the home) and not simply repairs (which restore the home's original value).  This second Help Article has additional information on this:  Can I deduct home improvements on my tax return?

Q3:  It depends.  If you are talking about your primary residence, then you will likely qualify for the Sale of Home Exclusion, which allows you to exclude up to $250,000 of profit from a home sale, (and $500,000 if married filing jointly).  To qualify as your primary residence for this exclusion, you have to have lived in the house (as your primary residence) in at least 2 of the last 5 years.  However, if this is your secondary residence, you are subject to capital gains treatment.  In the 24% tax bracket, you will be subject to a 15% capital gains tax on the profit of the sale.  (Keep in mind Q2 above, as qualified improvement expenses will add to your basis in the home and lower the profit, or gain, on your sale).  With your income, you could also face the Net Investment Income Tax (NIIT) (additional 3.8 percent tax).  And, of course, your state will also tax you (you will want to see how your state treats capital gains).

[Carl]

Two potential/possible IRS flag raisers here, as well as tax liabilities being created that do not need to be.

- When renting property to family, and when paying family for childcare, both of these "may" require special attention on the tax front.

- So you're going to pay your parents $1500/mo for child care. That's taxable and reportable income for them. In addition to the regular tax that will be assessed on that income, they'll have to pay the additional 15% self-employment tax.

Then you're parents are going to turn around and give you that $1,500 back for rent. So you'll end up reporting that as rental income and definitely raising your AGI another $18K. First, you take $18K a year of money you've already paid taxes on and pay your parents with it. Then your parents pay you that $18K back as rent, and that same $18K is reportable as income to you *again* (potentially taxable too!) thus raising your AGI another $18K. This makes no sense.

You're better off converting the property to personal use (assuming it's classified as a rental already) and let your parents live there for free, in exchange for childcare that will "NOT" be a tax credit for you. But one advantage is that if each of your parent's earn less than $4,300 of *earned* income in the tax year, and you provide them more than half of their support for the entire tax year, you may qualify to claim them as your dependents.

Note that if your parents receive retirement income from an IRA, 401(k) or other type of pension plan (not including social security) then you would probably not qualify to claim them as a dependent.