What are the tax consequences of renting a home you own to a relative?

In normal circumstances, when renting a home or apartment, you’re entitled to a depreciation deduction for your cost of the house or apartment (except for the portion allocated to the land). This may result in a tax loss for you, even if the rental income is more than your operating costs.

If your tenant is related to you, special rules and limitations may apply.

What defines renting to a “related” tenant?

Renting to a relative includes your spouse, child or grandchild, parent or grandparent, and siblings.

Renting to a Relative with No Limitations

No limitations apply if you rent to a relative who:

  1. Uses it as his or her principal residence for the year (not as a second home or vacation home), and
  2. It’s rented at a fair rental rate (not at a discount)

You can deduct all the normal rental expenses, even if they result in a rental loss for the year.

(If you have a loss, however, it is a “passive” loss, which may be subject to a different set of limitations.)

Limitations for Renting to a Relative

The problem arises if you set the rent below the fair rental value. When the rental price is discounted below fair market value, you are considered to be using the rental property personally. You would then have to allocate the expenses between the personal and rental portions of the year.

Yet, since all of the rental days are treated as personal days when renting to a relative at a bargain rate, the rental portion is zero.

This means you would have to report all of the rent you receive in income, but none of your rental expenses for the home would be deductible.

Just as with nonrental homes, you would still be able to deduct the mortgage interest—assuming it otherwise qualifies as deductible—and property taxes.

Bottom line: it is important to set the rent at a fair rate, even when renting to a relative.

Factors to look at when determining a fair rate include comparable rentals in the area and whether “side” gifts were made by you to your relative which could be reasonably interpreted to be the bargain element.

More Information

If you have questions, reach out to us at 314-961-1600 or schedule directly here to discuss your situation.

David Smith helps businesses and individuals develop smart business practices for tax and accounting advantages as the president of Smith Patrick CPAs. He serves on MOCPA’s Legislative Policy Task Force and MOCPA’s Firm Leadership Committee. Reach him at 314-961-1600 or schedule directly here.

About Smith Patrick CPA

Smith Patrick CPA is a St. Louis-based, family-owned CPA firm dedicated to providing personal guidance on taxes, investment advising and financial services to small businesses and financially active individuals. For over 30 years, our firm has focused on providing excellent service to businesses, non-profits, individuals and government agencies in St. Louis and the surrounding areas. Investment Advisory Services are offered through Wealth Management, LLC, a Registered Investment Advisor.