Hopefully someone more versed in this area can chime in. Lets say I buy a two bedroom condo for my child to live in while at school.
Scenario 1:The roommate pays less than mkt value rent, my child pays nothing. I am assuming it is no longer a rental property, its just a second home, and I just claim those rent payments as miscellaneous income?
Scenario 2: I have my child pay mkt value rent, and the roommate pays mkt value rent. I believe it is a full fledge rental at that point, and I can take all the normal deductions, expenses etc. Can I give my child the rent payment since it would be under the allowable gift limit of 14,000?
Paying rent for your dependent child is not a gift and you don’t have to stay under the gift allowance (and it is only a reporting allowance, not an actual limit on the amount you can give).
If you accept rent, it is a rental property. If you accept less than the full rental value, it’s just a bad deal rental property. How you set it up for tax purposes is up to you.
When you say “buy for” your child, do you mean that you or child will be owner? It would better if it is you or it is a significant gift that would require filing a gift tax return.
Annual gift tax exemption is up to $15k this year. If you are married, you and DH can give up to $30k without needing to file a return. If you forgive rent, that is considered a gift.
If roommate pays rent, even at less than mkt value, I think you can consider it a rental. With no family relationship, it is assumed to be an arms-length transaction but best to confirm with your accountant.
Also, with estate tax exemption so high ($11.2M per person), even if you go over the annual git tax amount, no tax is due. You would just file a return and it would count against your $11.2 at death.
I see no reason you couldn’t gift the rent back to your child since it’s under the annual limit.
It might seem like overkill, but I’d put the rental asset into a separate LLC. Keep it differentiated legally from your main residence. It’s a great asset protection vehicle. I’m sure your child is responsible, reasonable and clear thinking. We rent to college students for a living… believe me…many are not. They can hurt themselves and your property in ways a normal person couldn’t imagine. And then they can sue you for their supposed damages. (oh the stories I could tell…). You don’t want your primary residence or other assets to be on the hook.
Do you think this unit will appreciate in the 4(?) years your child attends school? Do you see yourself holding this property after your child graduates - will you continue in the rental business?
If so, then the advantage to treating it as a real rental business is the ability to do a 1031 exchange at the time of sale. You get to roll forward all the capital gain - tax free - as long as you purchase something of equal or greater value. In addition, during the years of renting to your child you get the depreciation and other assorted expenses as write-offs. Sometimes the deprecation makes any actual profit disappear - on paper - during the early years.
Why would the OP give the rent to the dependent child and then take that money back in as rental income?
There is NO LIMIT to the gifts you can give anyone, there is only a reporting requirement if it is over $15k per year, but that requirement doesn’t apply to dependent children. Set up your little princess in a deluxe highrise in the sky if you want.
The gift tax rules do apply to dependent children. When children are under 18, there is a legal obligation of support so many types of payments are not counted. However, even contributions to a 529 plan are considered gifts - there is a special rule that you can front-load 5 years worth of gifts. The only exclusions from gift tax are medical and educational expenses paid directly to the institution.
Forgiving rent for a child over 18 is a “gift” even if they are a dependent. That triggers a filing obligation if it is over the annual exclusion amount. However, unless you have an estate over the $11.2M, there will be no real tax consequences.
@twoinanddone Clearly paying rent for my child is not a gift, when you are paying someone else. as this will be my third in college, I understand that. The issue is, once you are the owner, there are rules regarding not taking FMV rent for a property. If you let your kid stay there free, its just a second home, not a rental. Which is why I asked if I charge my child FMV, can I actually give her the money as a gift, only to have her give it back to me as rent.
@Momma2018 yes I would be the owner. The 15k exemption would more than cover her half of the rent. I do know there are strict rules governing renting to relatives, you lose some of the normal deductions associated with rentals if you charge less than FMV.
@dietz199 yes, I already have an LLC set up. I set one up a couple of years back with the intention of purchasing a rental but I never did. I agree that I want to put it under my LLC.
the roommate’s rent might fall into the category of “non profit rent”. That gets entered on the miscellaneous income line. But since it isn’t a business, there aren’t any business expenses to claim.
I know a certain number of parents do this kind of thing, but I’ve never thiugh about the tax angle, just the getting-cheaper-housing-for-my-kid angle.
So you’re okay with paying tax on the rent received from your child, paid with money you’ve already paid tax on? That makes no sense to me to put the money into a circular tax pattern.
What different does it make if it is a second home or a small business?
@twoinanddone, it makes a lot of difference. If you just let a family member live in a home you own for free, or significantly less than FMV, you can only deduct expenses up to the rent you receive. If they pay no rent at all, then you are only deducting the interest, taxes etc on your schedule A as it would be considered not a rental, but a second or personal home.
If you get mkt rate rent, you get to deduct all expenses, related to the property, including depreciation, which most times gives you a paper “loss”, so I wouldnt be paying tax again.
Depreciation gets recaptured when you sell it, assuming you sell for at least what you paid for it, which wipes out much of the tax benefit of a rental vs. a second home.
In addition, you will incur selling costs of anywhere from 5-10% depending on where it is and what the local taxes are on property transfers. Will it appreciate enough in 3 years to offset this?
Treating it as a second home in theory lets you deduct the mortgage interest and taxes, which are usually the largest expenses other than depreciation. However, the new tax bill may limit the deductions you can take for the mortgage interest and property tax, depending on your situation with your first home, making treating it as a second home less attractive.
You have to charge something close to market rate to a relative (you can give a good tenant discount of 10 or 20%) who lives there for it to be treated as a rental, and it has to be the relative’s principal residence. “Principal residence” can be a bit nebulous for a college student, but unless they actually move out of your house to there and do things like officially change their address on drivers license and bank accounts, etc, it likely won’t be their principal residence.
Depending on your income, you may not be able to take any rental losses until you sell the place.
And for practical purposes, the IRS has no way of really knowing whether you are charging market rent or not, unless you get audited. Not advocating cheating on your taxes, but that’s the reality.
There’s a lot of issues as you can see. The transaction costs may be the deal-breaker.
@notrichenough I plan on keeping it, assuming this pans out. The property is in walking distance of the school, so I dont think I will have problems keeping it rented.
You are correct, the new tax bill pretty much screws us on the deductions. I doubt we will have over the 24K that will be allowed.
I think I should be able to charge mkt rate. My child has to take out a loan for school this year, so she can use that to pay rent. We have covered everything up til now. I am just hoping I can make this happen. Its harder when you dont live locally.
I also have to figure out financing. If I get a long in my name, then transfer to the LLC, potentially the bank could call the note.
Theoretically this is a problem, but there is really no way for them to find out without doing a search at the Registry of Deeds or whatever. After a loan gets sold a few times, there is no one checking this stuff. And as long as you are making the payments, they don’t really care.
The IRS might care, too, but they have even less of a chance of finding out.
I’m intrigued by the IRS question. The lender will send a Form 1099 to the borrower, which would be @partyof5 personally, and then the LLC would take the interest deduction. This might raise a flag in the IRS system.
In the past I’ve obtained non owner occupied residential loans in the names of LLC’s and limited partnerships, and I’d recommend you look in to this.
There are more important considerations than just the financial ones mentioned above. Does your child actively WANT to live in the place you propose buying? Do you want to be an OOS manager? Remember, there will be things needed in the middle of the night- who does that maintenance? Do not expect your student offspring to have the time, skills or desire to manage the condo. Interior issues are the responsibility of the owner, not the condo association.
What if your kids wants to live in a dorm, life in a sorority or frat house, or elsewhere? Transfer schools, do a term or year away? Also awkward for your student to have to collect rent from classmate(s).
@HImom my child is currently living in the dorms and is ready to move off campus. She isn’t transferring as she is sophomore and highly doubt that she will be transferring. She would be living with a my friends daughter. We’ve been friends for over 30 years, so no discomfort paying collecting rent. At this point she is not joining a sorority and most black Greek orgs don’t have an official “house” so that won’t be an issue.
@wis75 she couldn’t care less who owns the property. The last thing I’m worried about is something going wrong in the middle of the night. We are currently renting now and I’ve never had to call the landlord in the middle of the night. She will call me and we will deal with it. I also have several friends in the area who can assist if necessary. I also may get a property manager but I will cross that bridge at a later date.
@sherpa I’m probably going to get the loan in my name and transfer to the LLC later in the interest of time.
@twoinanddone I’m aware of the higher down payment. It’s normally 25%.
@twoinanddone it just dawned on me that I don’t have to purchase this as an investor property since I am currently renting. We are looking to purchase again this summer. I will just purchase as a second home so the rates will be more favorable than purchasing as an investor.