Rental to Related Parties

[Terry D EA]

This has been tossed around a bit and if I remember correctly on this board as well. However, client rents a home to their daughter at a reduced rate. Reduced close to 50% of the fair rental value which makes this a personal use rental without the ability to deduct any expenses. I talked to this client about this last year about this being the worst form of rental there is but they apparently haven't changed anything. The rent received is taxable income according to everything I have read. I have read posts on the Drake board that because a definitive reference regarding the rent being taxable income was not found, then one does not have to report the rent as income. I personally say that is tax fraud by deliberately failing to report income. Does anyone have any references to share on this subject.

[jklcpa]

46 minutes ago, Terry D said:

definitive reference regarding the rent being taxable income was not found, then one does not have to report the rent as income. I personally say that is tax fraud by deliberately failing to report income. Does anyone have any references to share on this subject.

Yes, 280A(d)(2)(C) and 280A(d)(3). Safe link to Cornell Law: https://www.law.cornell.edu/uscode/text/26/280A

Another reference is Jackson, T.C. Memo 1999-226 where taxpayer was found to have rented to parents for less than he reported on his return, and rented it for less than fair value. Court reduced the rental income to the actual lesser amount, moved the mtg int and r.e. taxes to Sch A and disallowed the other expenses.

Rental income is still reportable and any expenses related to the period of personal use are disallowed other than the mortgage interest and real estate taxes that would go to Sch A. 

[BLACK BART]

1 hour ago, Terry D said:

...The rent received is taxable income... 

I agree with this 'cause many, many years ago IRS audited my client who rented a house cut-rate to his daughter. Back then you didn't have to list the total days rented, so I didn't ask about the low figure.  I don't remember how they did it (jacking the rent back up or cutting out the ducks) but anyway, he had to pay tax on FMV.

1 hour ago, Terry D said:

...that is tax fraud by deliberately failing to report income...

 Aw, he shoulda paid it but it's not that  bad.  Now if you want real live fraud, the above-mentioned client once bought into a scheme peddled by some fly-by-nighter while working construction in Arizona.  I told him that tinfoil-hat story {"Income tax is illegal because the U.S. isn't on the gold standard"} wouldn't fly, but the tax bill (zero) was too cheap to pass up.  He was audited one month after writing that on a 1040 and sending it in - had to cough up the tax plus a $500 frivolous return fine. For some odd reason he was never able to locate that "tax preparer" again.

[Richcpaman]

Terry:

The general rule is that the IRS will disallow "bargain" rentals to related parties.  Even to unrelated if no reasonable attempts to collect the rent are made.  If the market rate is $1,000 a month, and your client is charging the Daughter $500, then the IRS upon examination can impute additional rent income for the missing $500 for all the open periods.

There is allowance for some discount, and the IRS refuses to define what the discount might be.   50% is probably too high.  80% might be right.  I explain this to my clients and we make the adjustments to the Sch E. 

Get info from some realtors for market rent for similar properties in that area and go from there.

Rich  

 

[JohnH]

This has always been a bit confusing, although I understand the logic of the IRS position.  I have a situation where a taxpayer and his wife provide a home rent-free to the wife's sister and her husband.  The taxpayers own the home outright (no mortgage) and they don't take any tax deductions other than the property tax, which they pay.  Wonder if IRS would try to tax them on the FMV of the rent they don't charge the family member?

[easytax]

I have one client that has a daughter-in-law living in his "old" home (paid for, etc.) that he does not take any deductions for, etc.. The however here is that the daughter-in-law gives him 5-600 each month to pay the basic utilities, insurances, property taxes, etc. (he acts as an escrow agent basically). This is about half what he could "rent" the property for but the daughter-in-law needs housing, etc..    He is not renting the property, she is paying the 'costs". Was I wrong NOT taking this as a rental and doing a sch. E?

[Richcpaman]

Under JohnH's scenario:

No rent being charged, and you deduct the RE Taxes on the house.  IRS can not impute income, because there is no rent being charged, and no expenses trying to be taken.  (Ie., depreciation, utilities, insurance, repairs, etc, etc.)

Under EasyTax's:

There is rent being paid for the house.  Not enough for FMV, but payments are being made.  Maybe he is not in the business of renting property, so maybe the rent is reduced by expenses and goes to Line 21.  Otherwise, the IRS would impute income, and then create a Sch E for your client.  Because he is getting $$. 

It may only be to help defray costs, but could you send me couple hundred every month to help me defray costs?

Rich

 

[easytax]

55 minutes ago, Richcpaman said:

Under EasyTax's:

There is rent being paid for the house.  Not enough for FMV, but payments are being made.  Maybe he is not in the business of renting property, so maybe the rent is reduced by expenses and goes to Line 21.  Otherwise, the IRS would impute income, and then create a Sch E for your client.  Because he is getting $$. 

It may only be to help defray costs, but could you send me couple hundred every month to help me defray costs?

Rich

 

Thanks as all dollars are offset, so nothing to line 21.

        You did not get it yet???      The check (to help defray costs) is/has been in the mail ...      

[DANRVAN]

7 hours ago, Richcpaman said:

.  Otherwise, the IRS would impute income, and then create a Sch E for your client.  Because he is getting $$. 

Imputed rent? I have never heard of it.  It is well know fact that below fmv rent limits deductions under section 280A. Under what authority can the IRS impute rent which would otherwise be considered a gift?

[jklcpa]

^ exactly.  Any day that the dwelling unit is used by a related party or is rented to for less than fair rental value are both considered a day of personal use.  Exception to that is if the family member uses it as his/her main residence AND rents it for fair value, but if that family member is paying below market rent, then it is entirely personal use.

Maybe my 1st post was too vague, but this issue is clearly covered in pub 527.

I've also never heard of the IRS imputing rental income.

[jklcpa]

I had to look further to find that this imputing of rental income is a tax loophole that people take advantage of with owner-occupied properties so that they can report on Sch E and take the other deductions. In my brief search I found some articles about it but didn't continue digging to find any authority on it, but it must be there or at least not specifically denied, but it seems like a sham to me.

I would like to know though if the IRS actually does this in audits. I would expect more often for the IRS to disallow the deductions entirely based on the personal use issue rather than this imputing. Now this really has me wondering.... 

[Terry D EA]

Judy,

This too has been a bother to me. Like you, I have read several articles and wonder the same things. In my situation, this is a four bedroom home in an area where the FMR is $1477. My client is collecting $780.00 per month from his daughter. This is way below the IRS stated discount percentage and is not a rental but personal use. This equates to $9,360.00 in reportable income without the deduction of any expenses or depreciation. Yes, the mortgage interest and property taxes are deducted on Sch A. But in this case, there is no mortgage.

This house is also the daughter's primary residence.

I don't understand the imputed income either. It is possible the $780 per month could cover the utilities, property tax; etc. But, I have not found anything that substantiates the difference to be used as a gift.

This client has been misinformed by someone. They even stated they "heard" that they qualified for the EITC. Well at 67 and 79 years old........

[Richcpaman]

5 hours ago, jklcpa said:

I had to look further to find that this imputing of rental income is a tax loophole that people take advantage of with owner-occupied properties so that they can report on Sch E and take the other deductions. In my brief search I found some articles about it but didn't continue digging to find any authority on it, but it must be there or at least not specifically denied, but it seems like a sham to me.

I would like to know though if the IRS actually does this in audits. I would expect more often for the IRS to disallow the deductions entirely based on the personal use issue rather than this imputing. Now this really has me wondering.... 

JK:

They may not  "impute" income, but they will do what you describe, which is to disallow all the deductions, and show all the use a personal. 

Rich

[Terry D EA]

Just to add to my post above. I think it would be a hard sale to label this as a not for profit activity when the rent received clearly more than the expenses, Just trying to rule out everything.

[jklcpa]

2 hours ago, Richcpaman said:

JK:

They may not  "impute" income, but they will do what you describe, which is to disallow all the deductions, and show all the use a personal. 

Rich

Thank you, Rich.  That does make sense to me and does follow the law.

[DANRVAN]

9 hours ago, jklcpa said:

 I would like to know though if the IRS actually does this in audits.

The only imputing rule I can think of is for below low market interest loans under section 7872, which actually makes sense.

 If there was a "general imputed income doctrine", we would be taxed on any returns we prepared for less than the going rate!

[jklcpa]

4 hours ago, Terry D said:

Just to add to my post above. I think it would be a hard sale to label this as a not for profit activity when the rent received clearly more than the expenses, Just trying to rule out everything.

This may have a positive cash flow, but once depreciation deduction adds in to the expenses, the ones I've seen would have ended up with a tax loss if left on Sch E.

[DANRVAN]

7 hours ago, Terry D said:

Just to add to my post above. I think it would be a hard sale to label this as a not for profit activity when the rent received clearly more than the expenses, Just trying to rule out everything.

Terry, the issues here is not "for profit".  Section 280A disallows most expenses for a personal residence when rent is below  fair market value. The only allowable expenses are for those that go on schedule A, property tax and mortgage interest.  Section 280A closes a loophole of writing off personal expenses of a second home owned by the taxpayer, regardless of who lives in it.

It's different for a business. You can charge half price for tax work and still write off all your office expense as long as you are still doing it for a profit.

[Terry D EA]

I agree. I stated the "not for profit" issue simply because it had been mentioned as a possibility to classify this activity this way to avoid including the income on the Drake discussion board. I know that this is not possible. Thanks for the clarification.