Tax Advice - College Rental Property

San Diego, CA · Member since 2016 · 13 posts · 5 votes

I bought a property last April that my son and 2 college student roommates are living in. Getting ready to do taxes for the 1st time since purchasing. Do I treat the property as 1/3 second home that my son lives in and 2/3 rental? Or just treat as a 100% rental and include my son's rent payments as income? Do I have an option? If so, is there an advantage to doing it one way or the other? Thanks in advance for any advice.

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Ashish AcharyaBusiness Member

CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes

Originally posted by @Brian Henry:

@Ashish Acharya - Thanks for the insights.....it does seem complicated. My understanding is that I could treat 1/3 of the house as a residence (the part my son lives in as his primary residence for the year).....and for that part I could deduct 1/3 of the mortgage interest and not record any income from my Son (which is really from me redirecting money I would have paid the college or a landlord for his rent). I could then treat the remaining 2/3 of the house as a rental....reporting the income and depreciating 2/3 of the house and writing off 2/3 of the expenses?

I have not run the numbers to really know whether this is better than just treating the whole thing as a rental.......It would seem a lot cleaner and simpler to make it 100% rental

@Michael Plaks , Please correct me if I am wrong, but the house he is renting to his son cannot be his personal residence. It can be his qualified residence-second home (if he only has two houses ), and he can itemize his deduction Like you mentioned above.

If this is not your second home, you can not itemize deduct if you were planning to.

Difference between a primary residence and qualified residence is important because you do not get sec 121 exclusion of 500k when you sell the qualified residence.

Also,

If you son pays the rent and if it is his primary residence, It will be 100% rental so no issue, but I understand that you do not want to do that because son basically is paying your money back to you ( if he does not work) and you will get taxed twice for that money . However, if he works, it's better for him to pay you the rent because he would be paying rent to someone else if you were not in the picture anyway. And, you get to treat he house as 100% rental with no complication.

BUT, Most likely this is going to happen:

If your son doesn't pay rent (or pays Below FMV) even though if it is his primary residence, so the house is considered Residence with personal use and your income is limited as mentioned above.

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Ashish AcharyaBusiness Member
CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
8y
@Brian Henry ,
Note: A taxpayer's dwelling used for personal purposes for more than 14 days during the year, or more than 10% of the number of rental days if greater, is considered to be a residence.
Also, a property generally is considered used for personal purposes if it is used by a member of his or her family.
However, the dwelling is not considered used for personal purposes if
1) Rented at a fair rental price to a family member
2) Member uses it as his principal residence
A residence with a combination of personal and rental use is considered a Property with personal use and vacation home rules apply.
So two cases:
1)
If you meet the requirement is the case, the property will be rental and you can deduct all the rental expense and depreciation.
- Income: report all Income, even from son.
- Expense: deduct all the income. There is no limitation on expense.
2)
If the property is not the primary residence of your son, renting to a family member cause the portion of the property to be considered the personal property of yours (but not a principal residence). You cannot depreciate or expense the portion that is your personal property and your expense is limited to Income.
- Income: Report all the rental income from roommates.
- Expense: Since only the portion of the house is rented, the expenses is divided based on the portion of the house that is rental vs personal. The deductible rental expenses cannot be more than gross rental income. On that limitation, the rental portion of interest and taxes are not limited but the operating expense and depreciation are limited to rental income, so cannot be more than rental income.
So as you can see which one is more advantageous. Good luck.
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Brian Henry
OP
San Diego, CA · Member since 2016 · 13 posts · 5 votes
8y
@Ashish Acharya - Thanks for the insights.....it does seem complicated. My understanding is that I could treat 1/3 of the house as a residence (the part my son lives in as his primary residence for the year).....and for that part I could deduct 1/3 of the mortgage interest and not record any income from my Son (which is really from me redirecting money I would have paid the college or a landlord for his rent). I could then treat the remaining 2/3 of the house as a rental....reporting the income and depreciating 2/3 of the house and writing off 2/3 of the expenses?
I have not run the numbers to really know whether this is better than just treating the whole thing as a rental.......It would seem a lot cleaner and simpler to make it 100% rental
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Michael PlaksPro Member
Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
8y
@Brian Henry
I assume than not only your son is not paying you any rent, but he is also your dependent on taxes and not working.
Then 1/3 of the house is a personal residence, and you can only pick up 1/3 of mortgage interest and 1/3 of property taxes on your personal itemized deductions (Schedule A). If you do not itemize your personal deductions - then those two deductions are lost.
You also have a rental property to be reported on Schedule E with 2/3 of every number, except 100% of rent. 2/3 of mortgage interest, taxes, insurance, maintenance, utilities and depreciation.
Now, if your son's roommates are paying less than the market rate - then it's more complicated, per @Ashish Acharya's post.
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Brian Henry
OP
San Diego, CA · Member since 2016 · 13 posts · 5 votes
8y
Thanks @Michael Plaks. That makes sense......I understand it will just be a bit more complex until after he graduates and it becomes 100% rental.
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Ashish AcharyaBusiness Member
CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
8y
Originally posted by @Brian Henry:

@Ashish Acharya - Thanks for the insights.....it does seem complicated. My understanding is that I could treat 1/3 of the house as a residence (the part my son lives in as his primary residence for the year).....and for that part I could deduct 1/3 of the mortgage interest and not record any income from my Son (which is really from me redirecting money I would have paid the college or a landlord for his rent). I could then treat the remaining 2/3 of the house as a rental....reporting the income and depreciating 2/3 of the house and writing off 2/3 of the expenses?
I have not run the numbers to really know whether this is better than just treating the whole thing as a rental.......It would seem a lot cleaner and simpler to make it 100% rental
@Michael Plaks , Please correct me if I am wrong, but the house he is renting to his son cannot be his personal residence. It can be his qualified residence-second home (if he only has two houses ), and he can itemize his deduction Like you mentioned above.
If this is not your second home, you can not itemize deduct if you were planning to.
Difference between a primary residence and qualified residence is important because you do not get sec 121 exclusion of 500k when you sell the qualified residence.
Also,
If you son pays the rent and if it is his primary residence, It will be 100% rental so no issue, but I understand that you do not want to do that because son basically is paying your money back to you ( if he does not work) and you will get taxed twice for that money . However, if he works, it's better for him to pay you the rent because he would be paying rent to someone else if you were not in the picture anyway. And, you get to treat he house as 100% rental with no complication.
BUT, Most likely this is going to happen:
If your son doesn't pay rent (or pays Below FMV) even though if it is his primary residence, so the house is considered Residence with personal use and your income is limited as mentioned above.
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2 Reply
Brian Henry
OP
San Diego, CA · Member since 2016 · 13 posts · 5 votes
8y
@Ashish Acharya & @Michael Plaks - It is only my second home and while my Son works a little, I had saved the money for his college housing expenses already and am using those funds to cover his part of the housing costs (which is still less than what he'd be paying to live on campus). And I do claim his as a dependent still.
So as I understand, I will have to take all of the qualified expenses and only use 2/3 of them on Schedule E and then be able to deduct 1/3 of the mortgage interest on Schedule A.
What about the costs of acquiring the property? We bought the house with the long term intent of a buy and hold rental (that our Son would live in for his last 3 to 3.5 years of school) even though it would also be treated as a 2nd home until our Son graduates. We traveled up to Idaho to look at properties and then all of the acquisition/closing costs and the expenses in repairs and getting it ready for renting.
We bought it in April and did not have it occupied until August. Do I treat everything as a 1/3 home and 2/3 rental right from the start?
Do you know if this type of scenario is spelled out in an IRS form? I have done my own tax returns for the last few years with TurboTax and would like to going forward but am wondering if this year may be too complicated for me to tackle on my own.
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Sam Shueh
Real Estate Agent · Cupertino, CA · Member since 2016 · 4k+ posts · 1k+ votes
8y
Keep it si,ple. 100% rental business. Report your income. It gets complicated as mixed later.
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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
8y
@Brian Henry, Run the numbers with your accountant but I'm having a hard time seeing a scenario where you would not want to make this 100% rental. Charge your son full market rent and then use gift limits to reimburse him for the rent paid. He's not hurt by the gift and you do have some additional rental income but easily offset by the now 100% rental designation including full depreciation. You could also hire him as manager of the house and 1099 him keeping his total compensation under next years whopper standard deduction. In that event you may even be able to eat into the income from the roommates.
Kiddie condos can be awesome.
Grab an hour of your CPAs time and proforma.
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Michael PlaksPro Member
Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
8y
@Ashish Acharya - of course you're right on the second home distinction. I was trying to simplify my answer, and the distinction you pointed out does not change the bottom line.
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Michael PlaksPro Member
Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
8y
@Sam Shueh and @Dave Foster
While having 100% rental is simpler and more beneficial - you cannot manufacture facts. Not legally, that is.
You cannot simultaneously provide housing support to your son, to qualify him as your dependent, and then reverse this fact on another page of your tax return claiming the same money as income coming to you.
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Michael PlaksPro Member
Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
8y
@Brian Henry
You're correct. Treat this deal as two properties. 1/3 of everything, including acquisition and rehab costs, is the personal property. The other 2/3 is rental property.
The form is the same as any other rental property - Schedule E. The only trick is to enter 2/3 of every number.
Doing Schedule E for the first time on your own is possible, but mistakes are also possible, especially in the initial setup. My recommendation is to let a professional handle it the first year.
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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
8y
@Michael Plaks, But you can absolutely have a written enforceable lease with your son and charge him market rent, collect market rent, cash the market rent checks, declare the market rent as income, and give you son up to $14000 in cash gifts correct?
And you can also hire your son as a property manager and pay him appropriately for services legally rendered providing him with an appropriate 1099 or W2 as the case may warrant - correct?
Cash is fungible. the return lays out the legal nature of the activities right?
You make a good point on the dependency issue. The market rent and rate being paid by the roommates will be a factor as well. That is why I was suggesting some time with his cpa. It may be in @Brian Henry's best interest to forgo dependency or to make sure his income allows for dependency depending on the facts of the situation. The point is that it could be dealt with either way legally.
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Michael PlaksPro Member
Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
8y
@Dave Foster, you know we both like pushing the line, and I like your creative thinking. :)
This setup will lack economic substance, because his son does NOT have the money. I'm not even sure that you can have a legally valid lease contract with a person who has no money of his own, but that's for attorneys.
Point is - dependency or not, this suggested transaction is a round-trip and, as such, will not hold water if challenged. If I was on the other side of this argument, i.e. the IRS side, I would destroy it.
I'm waiting for someone to suggest that @Brian Henry can simply ignore his son's living there and pretend that the house is 100% rental, with only 2 tenants. This would be the simplest and the most beneficial approach, by far. With one minor inconvenience of being untruthful representation and therefore illegal. For a lot of people, this would not be an obstacle.
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Brian Henry
OP
San Diego, CA · Member since 2016 · 13 posts · 5 votes
8y
@Michael Plaks - I am definitely looking to handle this correctly and will take your advice and seek some professional help this year to make sure I get it right. Definitely appreciate the sage advice.
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