FMV OF Rent - How low do you go?

[taxea]

How do you verify that TP is asking FMV on their rental? Are we really expected to research this? What do you do?

[joanmcq]

If it seems low, well, are they renting to their kid? Their mom? Then I might check it out. But since I'm a landlord, I kind of have an idea of rents, at least in my city.

I might ask if it was rented all year if the total rent seems low. It's not unusual to have a place vacant for a month or two between tenants, or longer depending on the rental market. So, it depends. I like to chat a bit with my landlord clients anyways, though.

[DTS]

Check with property mgmt companies within that city or county.They have been very helpful to me in the past.

[taxea]

I know there are on-line sites where one can check the FMV in any area. I am more curious about whether anyone knows of or uses a "rule of thumb" when the rent is lower than FMV and how much lower can it be before it is considered personal use.

Joan-I know that the renter doesn 't really have to be a relative if the rent is low enough. The IRS will still consider it personal use but I can't find anything anywhere (other than the one cite on Erchess' post) that speaks to how strict the IRS rule is.

Where are we to draw the line? 3%, 5%, 10% 20%? or as in the case cited only when the owner manages the property themselve, perhaps one could subtract the going management percentage of 10% of rent (FMV). This is going up here to 12%.

See where I am going with this? I have a friend, not a client, that lowers the rent for all tenants using the reasoning that if she makes the rent lower than FMV they take better care of the place. I can't convince her otherwise and I am quite surprised that her preparer hasn't figured out that none of the10 rentals are at FMV.

[S T]

I believe you would first have to "establish" FMV" rents in the area - thereby contacting real estate agents for comps, or establishing a base for "similar" properties in similar geographic areas.

There needs to be a baseline.

If you are discussing Residenitial Rentals - Hud has a sight that might be helpful http://www.huduser.org/portal/datasets/fmr.html One would think that you could use HUD as a baseline - and then +/- for your location and condition of the property.

Given the economy now - as a landlord - if need be I would rent well below the FMV if needed to have income versus having the unit vacant, and NO Rent. We have had to make these concessions on some Commercial/Office Space that we own.

Example: a Unit that should have a rental value of $ $1,300 - vacant for 3 years - NO INCOME but continuing costs on the Unit. Finally leased to a new ""start up biz" as a Self Employed - has a Good credit Rating and background - just going to take them some time to establish and have cash flow - Pay the Lease amount like "clockwork" on time - Checks are good and no issues with them maintaining the space ----- leased on a sliding scale of monthly lease escalation over a 2 year period starting at $500 - end of 24 months $ 1500.

Am I ahead of the "game" by doing this - after 3 years of vacancy and no income on the unit - I believe so ---- would I be able to convince IRS --- I would hope so - I was able to convince the Property Tax Assessor to lower the Property Assessment due to Vacancy for an extended period of time - which does reduce the Proprrty Assessment Value of my Property.

Am I leasing a Property or (in this case Unit) less than FMV - of course I am - but it is better than having the Unit still Vacant and no lease value being received.

I believe it is facts and circumstances - Homework needed - and do not Rent or Lease to a Relative - then that is one hurdle you will escape.

Of course now I am mixing Apples and Oranges ------Residentail Rental vs Commercial Rental.

Different perspective and my 2 cents worth

Sandy

[joanmcq]

FMV not a hard and fast figure, taxea it is what someone is willing to pay and someone is willing to sell in an arm's length transaction; in your case Sandy, FMV is exactly what you rented it for. It ain't worth $1300/month or it would have rented for that. It may have once been worth that much, but it isn't now.

The FMV issue comes into play for family BECAUSE of the possibility of personal use, that the transaction is not 'arm's length'. And unless you have an apartment building with lots of identical units, no rental is exactly like another. And even with the apartment building, one unit might have a better view, or be on a higher floor, or have newer appliances than another. And what is of value to one person is not of the same value to another. For example, I have two houses, of approximately the same size. One has central heat & air, but no garage and is on a busier street. The other doesn't have central, but does have a garage, and is on a quiet street. I rent both for the same amount. But the tenant that thinks A/C is a requirement for a house is not going to value the houses the same.

Your friend rents for lower rates thinking she gets better tenants that way. I can tell you that pricing your rental at the high end of the market gets you less inquiries if vacancies are high in your area. A drop of only $25 under 'normal' can get more inquiries and thus a larger pool of prospective tenants to choose from. And as Sandy knows, having the unit vacant can lower it's value to the seller.

You seem to be of the mindset that there is a 'rule'; some hard and fast number that is or isn't acceptable. But there isn't a hard or fast number for what FMV is, so how can you get a hard/fast % for what below that number is?

My point with who the tenant is, is simply that if my client is renting to mom, and the rent seems low, I'll have the FMV talk. But if it is to a stranger, I might inquire to make sure they aren't bartering rent (understating income), but I'm not going to worry about it being personal use. It won't be.

[taxea]

My bottom line is always "can I justify this to the IRS" in an effort to keep my clients from audits wherever possible. This issue is one where there does not appear to be clear guidance other than FMV or personal use.

I just wondered how the rest of you looked at it and I thank you for all of your responses. I feel much more confident that I can argue the issue with the IRS if necessary.

[Gary2]

How likely is this to be an issue if a) the tenants aren't relatives; and b) the rental is showing a profit? In theory, this could still trigger the personal use rules, but it's not something I'd suspect unless the rent really seemed questionable.

If the rental is showing a loss, then it could trigger the not-for-profit rules, even if the rent is fair. In such a case, showing that the rent itself is fair might help bolster the case for there being a profit motive, so it may deserve the extra effort, but focusing on actually making a profit may be a better use of time.

[joanmcq]

Or, if cash flow is positive, but there is a 'paper' tax loss. the early years of rentals often show tax losses because the depreciation allowed is more than the actual principal being paid on the mortgage.

I wonder about the profit motive of people who are showing huge losses year after year on rentals. One could in the past pull for increase in the value of the property, but nowadays that would be a difficult arguement....how long do you pour money into a property that is a loser?

[taxea]

many look at it as a way to save on taxes. Hard to justify when it is supposed to be a money making investment.

[ttbtaxes]

Or, if cash flow is positive, but there is a 'paper' tax loss. the early years of rentals often show tax losses because the depreciation allowed is more than the actual principal being paid on the mortgage.

I wonder about the profit motive of people who are showing huge losses year after year on rentals. One could in the past pull for increase in the value of the property, but nowadays that would be a difficult arguement....how long do you pour money into a property that is a loser?

You're correct that the dynamics of argument of the hobby-loss rules that allowed you to show that the gain in appreciation outstripped the losses have changed. I've read cases in the past where the IRS lost on this very issue. I have yet to see such a case since the downturn in the real estate market.

The taxpayer's argument today would be that since the rental property is already owned, the taxpayer would take a bath trying to sell it. The loss upon sale would be more severe than the rental loss incurred to hold and rent it. In such as case, the government's collection of taxes might not be prejudiced by the rental loss.

[jaybird]

TaxEA - that seems like a pretty reasonable business reason to have lower rents. Many people don't raise rents for years (even though the market would support 3-5% a year), just to try to retain good tenants. It would be pretty easy to jot down the costs of a bad tenant, and then use that to justify that having AND keeping a good one, is worth AT LEAST the monetary value calculated above, not to mention all of the time it will take to evict, and orchestrate repairs and such.

[taxea]

I thought that too...but just how much due diligence is expected of us regarding this issue. As a rule I don't ask the client or even check the area FMV unless the amount reported is extremely low and the rental was occupied the full year. I was just curious as to how far anyone thought the IRS expected us to go.

[jaybird]

I think our duty is to inquire and advise of the rules. It is up to the client to decide the actions to take from there. Document the conversation, maybe an email, then move on. If you feel the stance the taxpayer is taking is not within the tax law, or one that you do not feel you can substantiate, walk away. The risk is the taxpayer, after getting an audit and an adjustment, coming back to you and suing you for not advising. Documentation.

[Gary2]

The fundamental guideline is that you can't sign anything that would be incorrect, inconsistent, or incomplete, and you can't ignore anything that could lead to any of those conclusions. You're not required to be an expert in every business area, but if the numbers don't make sense, then they don't make sense.