How to claim all rental depreciation from a co-owned rental?

[Sarah515]

My dad and I own a rental 50/50.  He is going to allow me to claim 100% of the depreciation on my return.  How is that documented?  Or is that not allowed at all?  

[guywong]

You must have sound substantial economic reason in order to allocate Profit & Loss percentages differently from your ownership percentage.  IRS will not allow you to arbitrarily allocate income or deduction without economic reasons.

Here's an article on partnership allocations.  Coownership of rental properties follows similar rules.

https://www.thetaxadviser.com/issues/2020/aug/partnership-allocations-lacking-substantial-economic-e...

In Holdner, T.C. Memo. 2010-175, the Tax Court found that deduction allocations between a father and son farming partnership were not in line with the partners' interests in the partnership. The court proceeded to analyze each of the four factors above and largely concluded that there was "no credible evidence" for the special allocations. "[I]n the absence of substantial proof rebutting the presumption of equality, [taxpayers] had equal interests in partnership income, expenses, and other partnership items." The court presumed that the father and son each owned 50% of the farming partnership, and the taxpayers did not provide sufficient evidence to refute that presumption. As it was determined that the father and son each had a 50% interest in the partnership, the IRS's assessment of substantial-underpayment and accuracy-related penalties was upheld.

[Carl]

If the rental is owned 50/50, then all rental income/expenses are reported 50/50 on each of your tax returns. Now i myself had a situation where I purchased a rental, and the bank required a co-signer on the loan, and also required that co-signer to be on the deed. However, I was the one claiming all rental income/expenses/depreciation since I was the "controlling" authority (for lack of a better word.) Therefore, I was the only one to report all rental income/expenses on my own tax return. Years down the road when I could, I was able to remove my co-signer from the deed with the permission of the lender. However, they remained as co-signer on the loan until I paid it off in full about 8-10 years ago.

[Sarah515]

This is our situation.  My dad co-signed, but I am the "controlling" authority.  Thank you for your response!

[Opus 17]

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@Sarah515 wrote:

This is our situation.  My dad co-signed, but I am the "controlling" authority.  Thank you for your response!

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Make sure you can prove that you have the substantial ownership interest, that you pay all the bills, and are the owner except in name for purposes of the loan.  And keep your proof with your other important tax papers for as long as you own the property plus 3 years after you sell. 

[guywong]

@Carl @Sarah515  As long as the co-signer doesn't contribute any funds and you pay for all the down payment, the monthly mortgage payments, and all the maintenance costs, in my opinion, you meet the substantial economic test and should be able to safely claim all the income and deduct all the expenses on your Schedule E rental schedule.

[Sarah515]

@guywong All of that applies, except for the down payment.  My dad paid 50% of the down payment, and he co-signed, he does not do anything else with it, and does not want to claim any of it on his return.  I manage the rental, collect rent, pay the HOA, do maintenance and repairs.  But I absolutely consider him 50% owner as I said in the original post.  If only one of us is claiming anything having to do with the rental, do you think that still maintains the spirit and intent of the tax law?     

[Opus 17]

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@Sarah515 wrote:

@guywong All of that applies, except for the down payment.  My dad paid 50% of the down payment, and he co-signed, he does not do anything else with it, and does not want to claim any of it on his return.  I manage the rental, collect rent, pay the HOA, do maintenance and repairs.  But I absolutely consider him 50% owner as I said in the original post.  If only one of us is claiming anything having to do with the rental, do you think that still maintains the spirit and intent of the tax law?     

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If your father paid 50% down, you will have a very hard time proving (if audited) that you are entitled to 100% of the depreciation.  

If you are the only person paying for maintenance, utilities, repairs, and the mortgage, then over time, your ownership percentage will gradually increase.  You might want to have a partnership agreement in writing that spells out the percentage of ownership and each owner's responsibilities, that would allow you to claim an increasing share of the rental over time.

But as things stand, I think you are at risk of over-claiming depreciation, and your father is at risk. for underreporting the rental income.  You may want to discuss this with a local tax professional. 

[Sarah515]

That's what I was thinking too, thank you.

[guywong]

@Sarah515 I agree with @Opus 17  especially if you considers your dad to be a 50% owner.  My only thought on this is that what was your dad's intent for the down payment?  Does he think he's a 50% owner as well?  If not, could his down payment be a gift.  Was his share of the down payment below the annual exclusion amount?  Did he file a gift tax return?

If your dad considers himself a 50% owner, then I would think he should pay for half of the mortgage payments and maintenance costs.  

Since you're paying 100% of the mortgages and maintenance costs, I would think you should be able to deduct 100% of the mortgage interests and maintenance costs.  On depreciation, may be you should only enter half of purchase price + closing costs (less land portion) as basis into TT in year one since you only owe half of the property.  Your ownership percentage would increase each year by the principal repayment since that's the only amount not deducted on Schedule E.

[Opus 17]

I think I agree that, as far as routine expenses are concerned (taxes, mortgage, repairs), @Sarah515 can probably deduct 100% of those costs if they pay 100% of those costs.  (Although I am willing to be persuaded otherwise.)  However, deprecation of the main asset (plus depreciation of any improvements) must be split among the owners.

Also note that when you sell, you must recapture (pay tax on) any depreciation you did or could have taken as a tax deduction.  So even if the father never deducts depreciation, that depreciation still occurs and must be repaid.

If the father doesn't want to be an owner, he can give you his half of the property and then you really will be a 100% owner.  But a gift must be no strings attached, with no secret backdoor deal to repay him some day.

Or, the father could sell his interest to the daughter, who would consider it a second mortgage.  The child would be the 100% owner and would deduct all expenses including depreciation, loan payments to the father would be a deductible expense against rental income, and the father would report interest income as taxable income (the father must charge at least the applicable federal minimum rate, or higher).   However, note that taking out a second mortgage (even if financed by the father) could cause problems with the first mortgage.

If you can sit down with a good accountant and tell them what you really want (was dad helping you buy a property or does Dad consider this an investment that will earn him money as well), the accountant can figure out the best way to structure the arrangement. 

[Sarah515]

All good questions.  My dad did this to help me out, and his intent is to let me claim all the depreciation because I manage the property.  I believe he would say he has a interest in the property, but for all intents and purposes, it's mine.  Honestly, it was a way for him to dump some cash into an investment he didn't have to put any effort into.  

The 50% down payment was well over the gift limit.  

[Opus 17]

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@Sarah515 wrote:

All good questions.  My dad did this to help me out, and his intent is to let me claim all the depreciation because I manage the property.  I believe he would say he has a interest in the property, but for all intents and purposes, it's mine.  Honestly, it was a way for him to dump some cash into an investment he didn't have to put any effort into.  

The 50% down payment was well over the gift limit.  

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There's no limit on gifts.  Form 709 is required if the gift is more than $17,000 per year, but that is only a reporting requirement so the IRS can keep track of large gifts. Payment of gift tax is only owed after a person's lifetime total of gifts plus estate is more than $13 million. 

[Anonymous_]

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Someone posted something concerning getting a co-signer off of a deed, but deeds don't have co-signers and the first post in this thread is essentially correct; absent an agreement to the contrary, the default position would be income/expenses split according to the percentage of ownership.

If "Dad" is not one of the grantees on the deed (an owner), then @Sarah515 would be an owner in severalty and have 100% control of the property (again, absent an agreement to the contrary, but a deed will almost always control). As a result, @Sarah515 would report all of the income and expenses on @Sarah515's individual income tax return.

[Carl]

If the 50% down payment was a gift, or if it was a loan that you intended to pay back (and actually do pay it back), then there's really no issue with you claiming 100% of everything. Now if it was a gift, and that gift exceeded $17K in 2023, then the giver of the gift (your dad) will need to file a gift tax return IRS form 709 with the IRS. Take note that "NOBODY" will be paying any kind of a gift tax. It's just a legal reporting requirement that needs to be met.

So, if the 50% was more than $17K, if the form 709-Gift Tax Return is filed, that will help to "substantiate" your full claim to all the income, expenses and depreciation.

If it's a loan, then you'll need documentation between you and your father to prove it, in case you're ever audited.

Typically, I would see no reason for an audit unless there was something that "stuck out" on your return that got it flagged, or you have the experience of being one chosen "at random" for an audit for that particular tax year.