Q: My son is married with two children and he and his wife are elementary school teachers. You cannot afford to buy a home. My wife and I offered to buy a house for $ 320,000. We would make a $ 80,000 down payment on a $ 240,000 mortgage. We would then rent the house to them. But they would want to own the house after all. My thought is that I would sell the house to them piece by piece. For example, I could sell them 15% of the home for $ 12,000, which is 15% of the equity. You would then pay 15% of the mortgage, taxes, and insurance. I could charge rent for 85% of the house. This plan allows them to increase their possessions as slowly as possible. My son likes this idea and thinks it can work. But he asked me how we would report that for taxes and I have no idea.
A: Your proposal seems to make you and your son partners in this House. The partnership tax law is pretty clear. What is less clear is what a tax reporting partnership is? I don’t think you have a partnership.
A tax reporting partnership involves running a business with the intent to share costs and revenues. Your plan does not involve running a business or sharing income.
Tax law has something to say about co-ownership agreements that involve an owner’s personal use. When a property is rented to a family member, the property is generally treated as property for personal use unless the family member pays a reasonable rental value.
This means that if you own 100% of the property and rent it to your son, you can only treat the arrangement as rent if a reasonable rent is charged. That way, you can deduct all costs, including book costs and depreciation.
If a fair rent is not charged, even if it is 95% of the fair rent, your son’s use will be treated as personal use by you. You can deduct mortgage interest and property taxes (limited to a total of $ 10,000 on the sum of all property and income taxes you have paid), but not operating expenses or depreciation.
If it is a co-ownership structure, the law allows you to treat your ownership interest as a rental investment, provided your son pays a reasonable rent for the percentage of the property you own. However, this is only the case if ownership is what the law calls a “shared equity financing arrangement”.
You will likely want to report your ownership interest as a rental investment. This requires two things. First, a common equity financing structure. Second, a reasonable rent will be charged for your ownership interest.
I can’t tell you what fair rent is, so I’ll focus on the first part. A shared equity finance arrangement requires that both you and your son have a “qualified” interest, that one of you uses the property as their primary residence, and that the party using the property pays the rent for what they share does not own.
When properly performed, you can report a rental property for your percentage and claim all operating expenses and depreciation in addition to interest and taxes (not limited to $ 10,000 as they relate to an investment).
Your son can exclude any realized profit from his share if he owns the property for at least 2 of the 5 years prior to the sale and uses it as his primary residence.
To do this “right”, both you and your son must have an undivided interest in ownership. The best way to do this is to have separate deeds for partial shares of ownership. Your plan will make this a hassle if you want to allow your son to grow his interest regularly.
The tax law recognizes “fair” property. This means that the person has the “benefits and burdens” of ownership with no legal title. You may be able to clearly document the percentage your son has a fair title. This can be sufficient. It is risky, however, as there is no actual legal title and the IRS could easily argue that it is not a qualified property interest.
Jim Hamill is the director of tax practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at [email protected].