Rent between related parties?

[tacks]

A self employed woman wants to deduct a small aount of rent expense which she paid to her aunt for the use of a spare room. I don't think it would be a problem provided the aunt recognizes rental income recieved. Right?


The woman's aunt is retired and on a fixed income. She lives alone in a very large house. The self employed woman has full access to a spare room in her aunt's house which she uses for storage and sometimes as an office.

The self employed woman states that she paid cash to her aunt. The self employed woman is showing no Home Office expense nor any other rent expense. (which is another story)

If it came under audit i'm thinking that the aunt could produce a signed 'receipt' for the rental income. (but i would ask first to confirm)

[Snaggletooth]

Think So

A self employed woman wants to deduct a small aount of rent expense which she paid to her aunt for the use of a spare room. I don't think it would be a problem provided the aunt recognizes rental income recieved. Right?

So long as the aunt is paid for the rent, the rent is a deductible expense, subject of course to the eternal "ordinary and necessary" qualifiers.

From the aunt's perspective, it's not that simple. Does she meet the definition of a "related party?" If so, she can't report a loss unless she is charging FMV for the rent. Her income requirements might not be great enough that she is required to file a return. Also the matter of "depreciable" expense whether she takes it or not. I can understand why she would just not want to fool with it. She needs to talk to her own tax source about how to handle this.

[kaimana]

Snaggletooth is right on all points. It is not your client's concern whether the aunt reports the rent. If your client intends to take an expense for storage, that would be acceptable.
However, I would instruct your client to write a check for the rent so that she can justify the expense should the IRS question it. If the aunt is taking cash, I doubt, unless you know better, that a receipt is being issued.

[tacks]

Thanks

Thanks to the both of you for responding.

However, I would instruct your client to write a check for the rent so that she can justify the expense should the IRS question it. If the aunt is taking cash, I doubt, unless you know better, that a receipt is being issued.

Yes, i agree that writing checks is the better way to go. And I have told the woman that.

But the self employed woman claims to have paid some cash over 2008 (which may or may not be true -- i honestly don't know)

And I believe that the aunt would willingly provide signed 'statement' or 'receipt.'

So my question, really, is whether an invoice signed by the aunt, after the fact, and rental income on the aunt's return would suffice if the self employed woman came under audit. I would want to warn these people if there is any risk involved.

EDIT to add:
I'm concerned that an agent might view it as a scam for the self employed woman to evade the self employment tax -- funneling income to her aunt who's in a lower bracket.

[Gretel]

If it is not a problem for aunt to write a receipt if your client gets audited, then why not get a receipt now? I would be hesitant with the deduction if there is no receipt, the IRS wouldn't allow the deduction.

[JohnH]

Who knows if the aunt would even be able to verify that she received the rent if an audit came up a couple of years from now? She might be disabled, dead, etc by then.

I'd definitely have the client get a receipt and put a copy in my files. There's nothing wrong with an after-the-fact receipt - otherwise there would be no way to validate a claimed cash payment. It might also help if the client would furnish a picture or two of the area rented, showing how it is being used. Not a requirement, but a bit more supporting info.

I'd be a little more concerned about the whole thing if the business expense happened to have a significant EIC effect, but if the only thing affected is S/E tax and income tax, I'd be OK with the above documentation. (Well, I'd be OK with it unless my instincts tell me to dig a little deeper)

[tacks]

Thanks for responding, Gretel.

If it is not a problem for aunt to write a receipt if your client gets audited, then why not get a receipt now? I would be hesitant with the deduction if there is no receipt, the IRS wouldn't allow the deduction.

Thanks for responding, Gretel. You've answered my question.

I have no problem advising my client to show me the 'receipt/statement' provided by her aunt.