jklcpa and BulldogTom,
There is a Section 280A problem in this case. This is because: Prop Reg 1.280A-1(e)(5)(ii) provides that use by a beneficiary of the Trust is treated as use by the Trust. Prop Reg 1.280A-1(e)(2)&(3) provides that although there is an exception to Section 280A when a taxpayer rents out the residence as a principal residence to another (related) person for FMV rent, when the residence is rented out to persons having an interest in the residence, the exception applies only if the residence is rented out pursuant to a "shared equity financing agreement." Such an agreement requires an agreement between two or more persons who have an interest in the residence. (The reason for this requirement is that the Regs assumed that a person who is renting it out is not renting it out to himself. The case of a trust is an anomaly, where the beneficiary does not really own the residence but is deemed to own it.)
A workaround solution to the problem is to have a partnership own the residence. The partners would be: (1) the Trust which owns 99.9% and (2) a Trust with a different beneficiary (even a relative) which owns 0.1%. The two trusts would make a "shared equity financing agreement."
Note that the proposed regulations were issued in 1983. Technically, they are not binding, and are merely an indication of the IRS position on this matter. We could argue that the proposed regulations are poorly drafted, and there is no policy reason to require a "shared equity financing agreement" in our case. On the other hand, Section 280A(d)(3)(B)(i) does provide that the above exception "shall apply to a rental to a person who has an interest in the dwelling unit only if such rental is pursuant to a shared equity financing agreement." The Code does not define "an interest"; it is the proposed regs which do.
As I have a client in this situation, I am interested to hear your reactions.
