Personal use property is treated like a second home. You lose rental deductions\u2014but may still have to claim rents your family member pays you as income on your returns. Not a great way to maximize your tax efficiency.<\/p>\n
But by properly structuring your properties, you can rent to your family risk-free.<\/p>\n
Related<\/strong><\/em>: How Much to Charge for Rent in 2020: A Landlord’s Guide<\/em><\/a><\/p>\n Let’s start by defining the term \u201cdwelling unit,\u201d because it’s how the IRS divides property. A dwelling unit could be a:<\/p>\n However, it does not include property used solely as a hotel, motel, inn, or something similar.<\/p>\n Personal use of a dwelling unit simply means that you are using the property for your personal needs. You’re not making a profit by renting it out. Generally, second homes qualify as personal use.<\/p>\n There’s nothing wrong with personal use property. There\u00a0is<\/em> something wrong when a property you believed to be a rental is categorized as personal use. Then, the tax deductions disappear\u2014and you may be caught holding the bag.<\/p>\n The IRS uses the “days of personal use” test to determine if a dwelling unit is a personal-use property or a rental. It’s simple, for the most part: Did you use the property for personal purposes for more than 14 days in the year? If yes, it’s a personal-use property… unless you use it less than 10 percent of the total days it is rented at a fair price.<\/p>\n Here’s the kicker: If family members live there rent-free, that counts as personal use. That’s because a day of personal use is any day that the unit is used by anyone who owns an interest in the property or their family members\u2014unless they pay a fair market rate. Lastly, anyone<\/em> who rents the property below-market could create a personal-use situation. Be careful with charity cases.<\/p>\n Here are some examples.<\/p>\n First, let\u2019s say you have a vacation home and you stay in it for two weeks\u201414 days\u2014during the year. It will be considered a rental property, and you won\u2019t have to worry about losing any deductions.<\/p>\n Related: <\/strong>Understanding Rental Property Depreciation: A Real Estate Investor\u2019s Guide<\/a><\/em><\/p>\n However, if you stay in the vacation property for more than 15 days or your child or relatives live there without paying rent for more than 14 days, you will need to resort to the 10 percent test. In that case\u2014assuming the property was rented at a fair market rate for 300 days\u2014you can use the property for personal purposes for 30 days, or 10 percent of 300, and the property will still qualify as a rental.<\/p>\n An accidental personal-use property can be trouble. If you have a net loss, you may not be able to deduct all of the rental expenses. And deductions such as depreciation, management fees, marketing, maintenance, and repairs may all be excluded from your return.<\/p>\n To ease the pain a bit, the IRS does provide some leniency. If you attempt to rent the property at a fair market rate, those days will count as rental days, not personal use days. So don\u2019t sweat it too much if you’re experiencing vacancies.<\/p>\n So what is a fair rental income? In short, it’s the average market rent for comparable properties. If you’re charging substantially less than other similar properties, the IRS will count those rental days as “personal use.”<\/p>\n Make sure to have proof of fair rent in your area, such as a print-off from Craigslist or Zillow. You can also have an agent run comps and provide you with a rental price range.<\/p>\n Unfortunately, to prevent your taxes from getting muddied, you’ll have to charge your family rent.<\/p>\n This can be a sticking point\u2014for good reason. Who wants to charge their child or parent rent? Aren\u2019t you supposed to be supportive and caring? When money is on the line, decisions must be weighed carefully. It’s wonderful to support family members, but if that generosity could severely hurt your business, a fair pricing model must be considered.<\/p>\n But a “fair pricing model” doesn’t preclude a discount. In the IRS’s eyes, you can provide good tenants with monthly discounts that any normal businessperson would find acceptable\u2014around 8 to 10 percent seems to be permissible. So if the normal market price is $1,500, you can charge their child $1,350.<\/p>\n With traditional rental properties, your excess expenses\u2014or any rental costs that exceed your rental income\u2014can offset income from other sources. That’s not always the case with personal use properties. In these cases, you will likely have to report the income but may not be entitled to your full deductions. Let’s break this down.<\/p>\n Income from personal use properties rented for less than 15 days\u00a0isn’t reported on Schedule E, like normal rental properties. Instead, your expenses\u2014like mortgage interest and property taxes\u2014are reported on Schedule A. You will not have to report your income on your tax return.<\/p>\n If you use your property as a home and<\/em> rent it for more than 15 days during the year, you will have to include your rental income on your tax return. If you used the property for less than 14 days, you\u2019ll report the rental on Schedule E, just like any other rental.<\/p>\nWhat Is Personal-Use Property?<\/h2>\n
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The Days of Personal Use Test<\/h2>\n
The 10% test<\/h3>\n
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<\/p>\nThe Fair Rental Income Test<\/h2>\n
Personal-Use Property and Tax Deductions<\/h2>\n
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