We are considering renting a room to one of our siblings temporarily. She’s moving out here for a new job, and since we live in an pricey area living with us will offer her a way to save up some money. On our side, we are two people with four bedrooms, so we have plenty of room right now.
Of course, horror stories abound when renting to family members. I don’t know what to say about that. I don’t foresee it being a problem as we are pretty close, and we are all responsible professional adults, but I’m sure everybody else says that as well. Being that we recently rented a unit from a another family member successfully, I also feel good being able to “pay it forward”.
We would collect “rent”. The idea is that she would pay 1/3rd of all utilities (gas, electric, water, garbage, cable, internet) plus some buffer for other miscellaneous household maintenance items. This obviously will be much less that what it would cost to share an apartment on the open market, let alone a studio. So she’s paying her way, but we aren’t making much profit if any, ideally preventing any guilt or resentment on either side.
The Problem: Fair Rental Price
But then I did some research about the potential tax implications. Is rent always taxable income, even if from a relative sharing a home? From what I can tell, the IRS says yes. (Someone please correct me if I’m wrong.)
However, if I am reading the IRS “Renting to Relatives” regulations right, the good news is that if I rent out the room at “fair rental price”, I can start deducting a portion of my expenses – including interest, taxes, repairs, maintenance, utilities, insurance, and depreciation. This has the potential to offset the rental income completely (resulting in no net tax owed), although I can’t create a loss since it’s my personal home.
The bad news is that if I don’t charge fair market rent, then I can’t deduct anything. 100% of the rental income is now fully taxable as passive income. Having to pay taxes on money that is basically covering the utilities just doesn’t sound right.
From anecdotal evidence, I’m sure compliance is spotty at best in this area. What if a son pays $200/month to live with Mom and Dad? But to fall in line with the rules, it seems like I should either (1) charge something close to “market” rent and maybe buy her a nice gift later or (2) not charge anything at all. My idea was simply have her pay some of the utilities directly. This way I don’t actually accept any money. Any suggestions?