Tricky rental question

[Gary2]

As long as a number of us are looking at the EA exam, here's an issue that came from one of the review questions I found:

I think we'll all remember that you can't take any loss on a vacation home rental, even if it's clearly a for-profit rental situation. However, you can deduct pro-rated expenses up to the amount of income on Schedule E.

I think we'll also agree that if the vacation home is rented for a few days to a close family member (say a child or grandchild) at a below-market rent, then it's obvious that that counts as a personal use day and not a rental day.

The question is this: Suppose there's plenty of fair market rental to strangers during the year (say $5000 gross fair market rent) plus a tiny amount of below market rental to the kids (say $300 gross below-market rent). And let's suppose the expenses are $5100. For the purposes of determining how much of the expenses can be taken on the Schedule E that year, do you use the total rent received of $5300, so that all the expenses can be taken? Or do you report just $5000 of income and expenses on the Schedule E, netting to 0 there, and with the $300 of below market rent reported separately on line 21, and the slim chance of taking the remaining $100 of expenses on Sch. A subject to the 2% floor?

Bonus question: If it's the latter case, and you can't use the remaining $100 of expense, suitably pro-rted, on Sch. A, can the amount be treated as a carryover loss for next year?

I'll omit the answer given in the review materials for now, until other people have chimed in. But if it's not obvious, I'm questioning their answer.

[Burke]

Well, that is an interesting scenario and I am curious as to the correct answer. I never heard of reporting the (below-mkt in your case) rent on Line 21 and taking any expense on Line 22, Sche A, except in the case of a single not-for-profit rental activity. But not in conjunction with a for-profit rental of the same property reported on Sche E. Is the case you are referring to also less than the 14-day/10% personal usage test for the whole year?

[Gary2]

Is the case you are referring to also less than the 14-day/10% personal usage test for the whole year?

No, that's not part of the question. Take it as a given that it meets the test for being a vacation home (i.e., more than 14-day/10% personal usage) as well as primarily for profit, so that the bulk of the rental income obviously belongs on Sch. E. In other words, it's contrived so that the only questions are what numbers to report as income on Sch. E and what is the maximum deduction allowed on Sch. E. Combined, those two questions will also answer what the bottom line income/loss on Sch E will be to carry over to page 1 of the 1040.

[Burke]

I have an opinion, but will await other pundits, since I cannot swear to an answer.
As far as the bonus question, if the Line 21 scenario is a valid one, I will venture that you cannot carry over the expenses to the following year in the event they are precluded by the 2% haircut. Gut response is, all goes on Sche E.

[appelman]

From my interpretation of Pub 527, p. 23,

I would say that you report all the rental income on Schedule E, because your property is considered rental property. You must pro rate expenses for the number of days of honest-to-God rental at FMV, using either the IRS method or the Tax Court method. You may then deduct them up to the total rental income, following the usual ordering rules.

[Kram BergGold]

Schedule E

I would report everything on Schedule E.

[Gary2]

My conclusion is the same as others, that all the income goes on Sch. E. That's not the answer in the study question, though the answer (unlike most), doesn't address this particular point.

I can understand the rationale that could allow people to play games with the amount of rent they charge to family. However, since it doesn't change the days of personal use calculation, it doesn't allow for an unlimited increase in deductible expenses. At most, it avoids the 2% floor.

[Burke]

My conclusion is the same as others, that all the income goes on Sch. E. That's not the answer in the study question, though the answer (unlike most), doesn't address this particular point.

Okay, I am waiting.......waiting..... what was the answer?

[Gary2]

Okay, I am waiting.......waiting..... what was the answer?

The answer provided in the study question used only the rent paid by the strangers at full market rates for calculating the limit on deductions. While it clearly explained that the below market rent days had to be treated as personal days both for determining whether the vacation home rules applied (obvious) and for determining what percentage of the indirect expenses (e.g. insurance) could be deducted, it was silent on the subject of how the rental income was calculated.

I will - when I get a chance - contact them and ask for clarification.