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Rental vs 2nd Property

I currently own an older home that I have made significant repairs to for 2019 .  My son lives in it for free. He did help with the improvements and pays for upkeep, utilities and such.  I've been researching and see that I could consider his labor under Barter for rent but I'm wondering if anyone else has experience with this or recommendations.  

This is a family home that has been passed from person to person in the family for years, I have no purchase cost but did pay for new roof, gutters, lots of structural repairs, and basically gutted the interior to make it livable. I'd like to find a way to recoup some of those expenses. 

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4 Replies
Anonymous
Not applicable

Rental vs 2nd Property

see this article. 

https://www.forbes.com/sites/janetberryjohnson/2016/07/27/tax-rules-for-renting-to-a-relative/#5dce5...

 

 

i'll give you the gist of what would go wrong

When a home is rented for fewer than 14 days during the tax year, the home is considered a personal residence. Mortgage interest and real estate taxes may be deducted as itemized deductions on Schedule A, and the owner is not required to report rental income.

When you rent a home to a relative, such as a spouse, child, grandchild, parent, grandparent, or sibling, any day rented at less than the fair rental price is considered a personal use day. To avoid having the rental days considered personal days, the property must be rented at fair market rates and be the renter's principal residence.

 

 

Rental vs 2nd Property

You are going to face (at least) two problems in this scenario:

 

1) The expenses you mentioned (new roof, gutters, remodeling) are improvements, rather than repairs, and, as such, you have to add them to your basis in the home (and you should be keeping track of your basis) rather than deducting them immediately.

 

2) Since you would be "renting" the home at, what appears to be, below fair rental value, you would have to report rental income on your income tax return but your expenses would be limited to the amount of income you reported (i.e., the income and expenses would be a wash, leaving you without being able to claim a loss).

 

You might want to consider consulting with a tax/legal professional in this matter for advice regarding estate planning with respect to this home and any other property, as well as maximizing the total return from the current situation.

Carl
Level 15

Rental vs 2nd Property

I see all kinds of problems here. I'll try my best to keep it as simple as possible. But it won't be easy.

1. The first thing to understand is that you can not deduct from your taxable income, that which can not be taxed in the first place. That means your son's "free" labor is not deductible on any tax return. Not ever.

2. My son lives in it for free.  When reporting that you are "renting" to family, that's an automatic flag raiser with the IRS. That's because there are additional rules that come in to play when renting to family. One of those rules has to do with renting the property at Far Market Rental Value (FMRV). Most of the time those renting to family charge well below the FMRV. When you do that, then carry over losses are not allowed. So you can only deduct the rental expenses up to your actual rental income for the year and that's it. Any additional expenses that exceed the rental income can not be carried over to the next year. You just lose it. Forever. That can (and will) hurt tax-wise big time later down the road when one of three things happens in your life. A) You sell the property, B) You lose the property due to something like a fire, hurricane or other disaster, or C) You die.

3. This is a family home that has been passed from person to person in the family for years, I have no purchase cost.  Actually, you do have a purchase cost, referred to as your cost basis. What that cost basis is, depends on "exactly" how you acquired the property. If you were given the property by the prior owner prior to their passing away, then as far as the IRS is concerned, it was a gift. A part of that gift would also be the original owner's cost basis, or what they paid for the property. So if the prior owner purchased it in 1960 for $3500 and when they gave it to you in say, 2010 it was worth $100,000, your cost basis is still $3500 since the IRS considers that original cost basis as a part of the "gift" given to you also.

Now if you inherited the property from the prior owner after that prior owner passed away, be it through a will or probate, then your cost basis would be the Fair Market Value (FMV) of the property on the date the prior owner passed away. *NOT* the date your name was put on the deed after the prior owner passed away. That FMV is generally determined by a licensed appraiser, and *NOT* by the county property appraiser. Remember, the county property appraiser only asses tax value for property tax purposes - not resale value. So typically the tax value will be anywhere from 25% - 40% lower than the true market resale value.

3. but did pay for new roof, gutters, lots of structural repairs, and basically gutted the interior to make it livable.  Absolutely none of what you state would be classified as a repair in the eyes of the IRS. Instead, they are property improvements. What's the difference you ask? Here's the "plain english" definitions of property improvements and repairs.

a) Property Improvement.

Property improvements are expenses you incur that add value to the property. Expenses for this are entered in the Assets/Depreciation section of the SCH E and depreciated over time. Property improvements can be done at any time after your initial purchase or acquisition of the property. It does not matter if it was your residence or a rental at the time of the improvement. It still adds value to the property.

To be classified as a property improvement, two criteria must be met:

1) The improvement must become "a material part of" the property. For example, remodeling the bathroom, new cabinets or appliances in the kitchen. New carpet. Replacing that old Central Air unit.

2) The improvement must add "real" value to the property. In other words, when  the property is appraised by a qualified, certified, licensed property appraiser, (not your county property tax appraiser.) they will appraise it at a higher value, than he would have without the improvements.

b) Repair

Those expenses incurred to return the property or it's assets to the same usable condition they were in, prior to the event that caused the property or asset to be unusable. Repair expenses incurred are only deductible if incurred while the property is classified as a rental. Repair costs incurred in the process of preparing the property for rent are not deductible.

c) Additional clarifications: Painting a room does not qualify as a property improvement. While the paint does become “a material part of” the property, from the perspective of a property appraiser, it doesn’t add “real value” to the property.

However, when you do something like convert the garage into a 3rd bedroom for example, making a  2 bedroom house into a 3 bedroom house adds “real value”. Of course, when you convert the garage to a bedroom, you’re going to paint it. But you will include the cost of painting as a part of the property improvement – not an expense separate from it.

Now I'll stop here because I think you've learned enough at this point to make an informed decision. However, if you do have more questions then by all means, please ask!

Rental vs 2nd Property

I appreciate your thoroughness.  I was trying to keep my message simple without overwhelming details.  From all of my research and everyone's input, I think I would be better off not doing anything with the property -tax wise.  I'm not trying to be sneaky, I have researched quite a bit on the topic. ..Replies per your bullet points- 

1/2.  I have found information about how to list Bartered services.  My son works in construction so his pay he earns as a carpenter would be very fair rate (FMV) for his Bartered rate.  I have also several examples of similar properties for rent and have  documented the similarities and differences to find a FMV for the home.   

3.  As I said I was trying to keep my message simple.  This home is a single wide mobile home, originally purchased by my husband as new in 1997.  It is already on family land but the land is in my mother-in-law's name. The land is not tied to the mobile home in the bank's eye, it has a title not a deed.  The taxes are paid on the property as improved property by her.  When a mobile is not tied to the land, taxes are separated.  My husband has let various family members live in it once he moved out.  The last family member moved out 5 years ago and left the home with repairs needed. There have been no deaths, no wills, no gifts. It has always been in his name.  The repair is an actual repair by my research.  The roof was original and had leaked for years, there were rotted walls, rotted floors, and actual holes in some of the roof/walls/floors. Animals were living in it. To me that falls under "unusable" and not an "improvement".  We have pictures and documentation for all of this.  Yes, we have improvements in new flooring, new cabinets, etc.  

My question that I guess I didn't make clear is would it be more complicated/feasible to claim this as a "Rental" (It doesn't look like that will be a good idea) or as a 2nd property which I suppose it technically is.  I haven't been able to find much information on 2nd property tax deductions.  Since there's no mortgage and we personally do not pay the taxes on the property, it appears that avenue would not be an option either.   Lesson learned I suppose.

 

 

 

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