Renting house to daughter-Amend?

[Happy Camper]

New client has a rental house in another state that she is renting to her daughter. Purchased the house in 2013 and has had losses on Sch E for the rental the last two years. The loss from 2013 created an NOL that was carried over to 2014 and the 2014 NOL is even greater.

I know there are issues pertaining to related party rentals, she could probably justify that the rental is at Fair Market Value as the daughter was renting the house before Mom purchased it for the same amount she is paying Mom. Also, I pulled the HUD FMR rates for the area and it is very close to that. However, I don't think long term this is a good solution. Mom's income is in 10% tax bracket and when/if the house is sold depreciation recapture is at 25%. Not to mention the issues with loss on related party rental.

Have discussed with TP and she would like to stop taking the rental as Sch E (just report interest & taxes on Sch A). Any suggestions on the best way to do this? Would you amend prior year returns or just leave them be? In defense of the prior preparer, TP said she may not have told them it was a related party rental...

[TaxGuyBill]

If it truly is a "rental", it needs to stay on E.

If the mother is allowing her child to live in her second home, and the child decides to contribute to some expenses, then it probably would not be income and the client would deduct the mortgage interest and real estate taxes on Schedule A.

You and the client need to figure out which scenario it is, and file taxes (and potentially amend) to whatever was being done. From your description, it sounds like a Schedule E rental to me.


As a side note, when the house is sold, the taxes based on the depreciation is taxed at ordinary tax rates UP TO 25%. So the first part of the depreciation would be taxed at 10%, and the next part at 15%. If there was a lot of depreciation, that 'extra' amount would be taxed at 25%.

[taxea]

Who pays for the repairs and other upkeep of the home? She may lose quite a bit in nondeductible expenses if the Sch E is not continued.

[Happy Camper]

Thanks for the input!

TaxGuyBill-I agree that it is legitimate as a Sch E, however considering Mom's taxable income is essentially zero after Sch A deductions, I don't see a benefit for the Sch E losses. Also, I think it increases her audit risk (with the continuing NOL's and the IRS may not agree that it is FMR), that is why I am thinking it would be a better situation to consider it Mom's second home. The only effect it is having to remove the Sch E is an that her Premium Tax Credit for Health Insurance is reduced so she would owe some of that back. (She is on Medicare as of 2016 so that will not be an issue in the future.)

I appreciate also the information on the depreciation when the house is sold is taxed at regular rates up to 25%. I guess the NOL carryovers may also limit the gains to the 10% tax bracket.

As taxea commented, she will also lose the tax deduction for repairs and insurance. Again, just not sure having the NOL's carry forward to offset the eventual gain on sale is worth the risk.

Curious, can it just 'drop off' as a Sch E without amending? Convert to personal use, recapture depreciation which would be offset by the NOL carryfwds?

[taxea]

If you don't continue to report it as Sch E you are submitting an incorrect return. Let the future take care of itself.

[Kram BergGold]

In 2015 it is rent

In 2015 the daughter paid the to the Mom the same amount she paid the previous owner and the amount is very close to a totally fare market rent. So there is nothing to do but prepare a Schedule E. Maybe at some point in 2016 the daughter and Mom can alter how they are handling this.

[taxea]

What is pretty close to FMV of rent? it is either FMV or it is not and majority of expenses go south because she can't report on a Sch E