Grandmother rents to grandson who rents out rooms to tenants

[origun]

Property is owned by grandmother who has a mortgage in her name. She doesn't live there but grandson does. He pays the mortgage and other household obligations (property taxes, utilities, HOA dues, etc.). He rents out several bedrooms to people (currently about 10 people!) who pay him anywhere from $350 to $700 per room. My question is who claims what income and expenses on his/her tax return. My first thought is that grandmother has a rental (to her grandson) and her income is the mortgage payments and property tax for which she is obligated to pay but someone pays for her. (So...does she depreciate the property?) Then grandson claims the rent he receives on his Schedule C with his expenses ("rent" he pays for grandmother's legal obligations, utilities, etc.). I don't believe there are any legal documents between the 2 people, just a verbal agreement.

It is doubtful he will accept my analysis if it is unfavorable to him and will probably go to another preparer or consider it all "under the table" income and forget about it...but I want to be able to give good advice.

[ATSMAN]

Property is owned by grandmother who has a mortgage in her name. She doesn't live there but grandson does. He pays the mortgage and other household obligations (property taxes, utilities, HOA dues, etc.). He rents out several bedrooms to people (currently about 10 people!) who pay him anywhere from $350 to $700 per room. My question is who claims what income and expenses on his/her tax return. My first thought is that grandmother has a rental (to her grandson) and her income is the mortgage payments and property tax for which she is obligated to pay but someone pays for her. (So...does she depreciate the property?) Then grandson claims the rent he receives on his Schedule C with his expenses ("rent" he pays for grandmother's legal obligations, utilities, etc.). I don't believe there are any legal documents between the 2 people, just a verbal agreement.

It is doubtful he will accept my analysis if it is unfavorable to him and will probably go to another preparer or consider it all "under the table" income and forget about it...but I want to be able to give good advice.

I have a client with a similar situation where his grand kids live on a 50 acre farm owned by the grand parents and rent out some land, a warehouse and do some farming. I don't do the grand kids taxes. The land owner has basically created an agent to rent out the property, so on his sch F we show rent received equal to property taxes and some utilities. The grand kids keep the income from farming and other rental activities.

[Kram BergGold]

Origun

I kind of agree with you. Remember, it is permissible to rent to a relative at slightly less than FMV. So for grandma I might report all the expenses the grandson pays as income, then take those as deductions and then claim depreciation. This would especially hold water if the property is in an area in which values are rising. Then the grandson reports all the rent he receives and claims all the expenses he pays. For the grandson I would not show a loss. To do so would be an admission of not engaging in an activity for profit. I might do this on C or E depending on how much service he provides.
Also, if he lives there you will need to do some allocating if he does not contribute some money.

[JudyL]

I'd take an entirely different approach than what's been discussed so far.

Considering the definition of a dwelling unit includes any day that a person rents to a relative at below fair rental value or rent-free, and that is the fact pattern being presented here, I believe that this would make the home ineligible for grandma to report as a rental since the grandson lives there year round. This means that grandma can't deduct expenses even up to so-called "rental income," and she must report the real estate taxes and mortgage interest on her Schedule A as a second home, if she is able to itemize.

Next, the grandson's payment of the mortgage might be considered a gift to the grandmother, so hopefully it is within the annual exclusion limit. Grandson can not legally deduct these as his expenses since he is not the property owner and has no legal obligation to pay them.

My question is whether the grandson is legally allowed to sublease out rooms or parts of the home, but whether legal or not, he has income to report and allocating of expenses.

My answers would be entirely different if it was found that the grandson is a life tenant in a life estate set up by the grandmother.

[TaxGuyBill]

Considering the definition of a dwelling unit includes any day that a person rents to a relative at below fair rental value or rent-free, and that is the fact pattern being presented here

I don't necessarily agree with that. I could easily consider the mortgage, property taxes, etc. the grandson pays as "rent", so I would not consider it as "rent-free".


As for if that is Fair Rental Value or not, I don't think we have that information.

As Kram pointed out, Fair Rental Value to a tenant that is known to be trustworthy and 'good' may be lower than Fair Rental Value to an unknown tenant. In other words, it could be slightly lower than similar rental properties, but still be considered as "Fair Rental Value".

But again, I don't think we have the information to determine if the total amount the grandson pay (mortgage, property taxes, etc.) is Fair Rental or not.



However, if it is considered less than Fair Rental Value, you are right, that changes the situation.

[taxea]

Grandma should enter into a detailed property/rental management contract with grandson. She then gets all the income and expenses and reimburses him for
expenses he pays out of pocket (not including expenses paid with rental income).

[Snaggletooth]

My commentsq

It is my understanding that in order to deduct interest and property taxes a party must:
(I) Be obligated to pay them.
(ii) Actually pay them.

If I am correct, those expense would thus be non-deductible.

The amount of rent received CAN be less than FMV, unless this creates a loss. A loss is non-deductible, and as far as I know, does not increase basis since these are related taxpayers.

[origun]

Clarifications

Thanks so much for input from such experienced people. A few clarifications/additions:
I would say that the mortgage and property taxes paid by grandson would be pretty close to fair rental value of property for the area. (I have consulted Assessor's Records online to get info about the property.)
I certainly agree that there should be a clear written agreement between the 2 parties but there isn't! The term "life estate" isn't in the vocabulary of the client! (I have no direct contact with grandmother, only grandson.)
Yes, grandson lives there along with others who pay him rent; I hadn't thought about allocating expenses between him and others but certainly makes sense.
I don't know if what he is doing (subleasing) is legal or not for the area where he lives...but I can't do much about that except ask him to check into it with County or HOA. It's a pretty loosey-goosey operation in my opinion.

[taxea]

Thanks so much for input from such experienced people. A few clarifications/additions:
I would say that the mortgage and property taxes paid by grandson would be pretty close to fair rental value of property for the area. (I have consulted Assessor's Records online to get info about the property.)
I certainly agree that there should be a clear written agreement between the 2 parties but there isn't! The term "life estate" isn't in the vocabulary of the client! (I have no direct contact with grandmother, only grandson.)
Yes, grandson lives there along with others who pay him rent; I hadn't thought about allocating expenses between him and others but certainly makes sense.
I don't know if what he is doing (subleasing) is legal or not for the area where he lives...but I can't do much about that except ask him to check into it with County or HOA. It's a pretty loosey-goosey operation in my opinion.

If loosey-goosey is the case I would advise the client to take the advice I posted above or I would make sure that the monthly rent received is a FMV and that it includes the grandson's portion. If it doesn't than it likely is not at FMV and all expenses would be limited, as well as his not being able to deduct property tax and interest on his Sch E.

[Twin Turbo Z]

It is my understanding that in order to deduct interest and property taxes a party must:
(I) Be obligated to pay them.
(ii) Actually pay them.

If I am correct, those expense would thus be non-deductible.

The amount of rent received CAN be less than FMV, unless this creates a loss. A loss is non-deductible, and as far as I know, does not increase basis since these are related taxpayers.

My understanding too. I know many moons ago, one could put down "mortgage interest paid on behalf of" and list the mortgage owner, their social and all the bank info and claim it. But I believe a court case, null and voided the "Paid on behalf of", and those deductions have to be in the name of the taxpayer. Or the taxpayers spouse if married.