Child's college home

[JenMO]

Father is looking into buying a house for son to live in while going to college. There will be two other boys living with the son and paying rent. Can this house be set up as a rental, reporting rent and taking off 2/3 of expenses? How can it be set up for the best taxable consequence? I've read about the mixed use property, but if son is there the whole time, too, does it all become personal. Could mortg and taxes be deducted as second home? Would rent be taxable with no deductions on Sch E if house is considered second home? Help!

[Koss]

Rental Property

I'm sure that some will disagree with this approach, but here it goes...

Best bet is to make the son a tenant also, and have him actually pay fair market value in rent.

And do it the right way, with a signed lease, and the whole nine yards. The father should set up a totally separate checking account just for the purpose of managing the rental property--maybe even do a single-member LLC, or register a fictitious name with the state, so the checking account can bear the name "John Smith Equities" or something like that. Okay, maybe that's a little too much baggage. But he's gotta have a separate account, and he's gotta collect three rent checks each month.

Once every three or four months, he can give his son a gift of cash, or in the form of a personal check, written from his personal checking account. The amount of this gift should not work out to be exactly the same as the rent, and he should not give his son the gift each month on the first day, or right after his son pays the rent. The gift transactions should have no direct connection to the rent.

The rent paid by the son will have to be reported as income on the father's return.

Do it this way, and do it right, and the father can deduct 100% of the expenses, along with full depreciation.

Son has to pay the same rent as the other two, unless there is some legitimate basis for making it less, i.e., the son has the smallest bedroom or something.

[JenMO]

In the TTB on page 7-7, it talkes about roommates and boarder. It says any reasonable method of allocating expenses between personal and rental use is allowed. The example says TP owns the house, if the son is a dependent of the father, wouldn't is be the same?
But then there is examples of mixed use property- vacation homes. Some places seem to contradict themselves.

[Koss]

Allocation

You make a good point. If the two analyses seem contradictory, it is because there is a very technical and very subtle distinction involved.

Schedule E, and the instructions associated with it, raise the question of whether the property is "personally used by the taxpayer," and if so, how much, or what percentage of the time. If the property is used personally by the taxpayer too much, then that can disqualify it as an income-producing activity. The rental of the property becomes incidental, and is viewed as not having a profit motive.

It is certainly correct that allowing your son or another family member to live in the property rent-free is a type of personal use.

This approach, and this section of the tax law, is intended primarily to address vacation homes, time shares, and other scenarios in which 100% of the premises is used by the taxpayer for part of the year.

The best example is in fact the time share. If I own a two weeks of a time share, and I rent it out for one week, and occupy it myself for the other week, then I am using 100% of the property half the time, and I am renting 100% of the property half the time. And that's not going to be seen an a business activity.

The college kid scenario you described can be viewed a different way.

You have to partition the property into two sections--one part of the property that is used personally by the taxpayer, and another part that is not. You then take the position that the part that is rented is not personally used by the taxpayer at all.

This is consistent with your original suggestion, i.e., that 2/3 of the property would be considered rental property, so you depreciate 2/3 of the value, take 2/3 of mortgage interest, real estate taxes, and other expenses, and so forth.

I used the word partition loosely. I certainly do not mean that the taxpayer has to ask the county to split the property into two parcels.

When it comes to roommates, or renting out one or more bedrooms within your home, I don't know whether this particular approach has ever been tested, or challenged by the IRS.

I believe that the partition concept is widely accepted in the case of a duplex, where the building owner lives on one side and rents the other side. Assuming that the square footage is an even 50/50 split, I am certain that it is an accepted practice to simply determine that half of the property is rental property, and the other half is the taxpayer's principal residence. You depreciate half the value. You put half the mortgage interest on Schedule E, and the other half on Schedule A. You put half the homeowner's insurance on Schedule E, and the other half is a nondeductible personal expense.

But when you attempt to partition a single residence, it becomes a little less clear.

Sometimes a person will rent out a single bedroom, which may have its own bathroom, with the understanding that the boarder does not have the privilege of using the kitchen, the living room, or any other area of the house. With this type of arrangement, determining what portion of the house is personal use and what portion is rental property may get kinda complicated.

If three people are really sharing everything equally, and all three bedrooms are the same size, it actually seems a bit easier to sustain the argument that two-thirds of the property is rented.

Your approach sounds defensible. Maybe I'm making this too complicated.

The question is this: What is your client really doing?

-- Is he using 100% of the property one-third of the time, and renting 100% of the property two-thirds of the time?

-- Or is he using one third of the property 100% of the time, and renting two-thirds of the property 100% of the time?

It's not "six of one, half a dozen of the other." LMAO

[Koss]

Tax Pro Humor

Q. When is 1.00 x .33 not equal to .33 x 1.00?

A. When it's a rental property that is personally used by the taxpayer.

[JenMO]

I really believe his intention is to rent 2/3 of the property 100% of the time. All three boys will live together while attending college. Father doesn't like to throw money away on rent , but doesn't need the extra income to pay taxes on if he is not allowed a deductions for the renters. He understands no deduction for son's 1/3. They are wanting to look at houses, but also wanted to know the taxable consequence. I feel is all boys share the whole house equally, 2/3 would be deductible, don't you?

[Koss]

Go for it

I would say go ahead and take the position that 2/3 of the property is rental property 100% of the time.

I still think that the two roommates should sign a genunine, enforceable lease, and that they should pay rent directly to the father. Keeping a separate bank account for managing the rental is not an absolute must, but it's a good idea.

With that said:

I also recommend that the father have a long and very detailed conversation with an attorney who regularly handles landlord-tenant issues and evictions before executing any type of lease.

This is not the same type of attorney that handles real estate closings. Those guys know all about the most technical aspects of real estate ownership, but sometimes they are incredibly clueless on the laws that apply to roommates and tenants.

I own rental property. I'm not an attorney, but I am intimately familiar with the law here in Ohio.

If he executes a lease with the two roommates, whether it is a joint-and-several-liability lease or an individual lease for each roommate, he needs to be very careful. If he uses a standard, traditional lease generated by an attorney who doesn't understand the special facts, or if he uses something off the internet or from an office supply store, he may have serious problems down the road.

A traditional lease will grant tenancy and all the associated rights to each of the two roommates.

If he doesn't execute a lease for his son...

Well, let's say the roommates somehow are not getting along.

Neither he nor his son will be able to throw the roommates out without going to court and using a formal eviction proceeding.

But one or both roommates might be able to order his son to leave the property, because without a lease, he doesn't have any legal right to occupancy. If the son doesn't have a lease and the other guys do... well, in some states, under certain conditions, the roommates might be able to simply call the police and tell him that he has to leave or he'll be arrested for trespass.

Yes, that's a worst-case scenario. But he needs to take a long look at this. I'm not saying he shouldn't do it. But he needs to do it the right way.