Cost sharing and filing status

[Potterwonky]

In a family cost sharing arrangement where the occupant paying less than FMV rent (for their own bedrooms but no lease) also has a qualifying dependent, as does the homeowner, can each claim head of household status?

If not, what would be the more appropriate arrangement?

[JulieS]

The person who actually pays more than half of the household expenses would be the head of household and the other person would be single with a dependent, or married if that is the case. 

With the head of household status, it ends up coming down to the rule that states "Heads of Household must pay more than half of the household expenses." By definition, two people can't pay more than half of the expenses for the same household. 

In your case, it seems likely the homeowner would be the head of household and the person paying a reduced rent would not. 

Total household expenses include mortgage or rent, property taxes, utilities, insurance, repairs, etc. 

As far as trying to establish a different arrangement, if you are all related, I am not sure you could defend any arrangement to the IRS.

[Potterwonky]

Thank you. This is helpful. 

What if the "renter" does pay FMV rent (prorated for the areas they use), income is documented and expenses deducted on Schedule E. Would this establish a separate household for tax purposes? 

[JulieS · Accepted solution]

Yes, that would support a separate household for tax purposes. My question for you is, do you think it is worth it?

If you do all of this to establish two separate households, one of you will get a larger tax refund. 

On the other hand, you need to establish fair market value rent, collect it and report the rent as income. That will allow you to deduct even more of your household expenses than you do now, but you will also be depreciating part of your home.

When you sell your home in the future, you will need to "recapture" your depreciation as ordinary income. 

Filing Schedule E every year will increase the amount you pay for tax preparation or software. 

You should consider this plan carefully. In the end, if you are audited, the IRS may still say this is one household because you are related.