But be aware of this often-ignored pitfall: Allowing friends or family to use the home rent-free could wipe out all those sweet deductions. That’s because rent-free use by friends and family counts as “personal use” of the home.
The rule: If your personal use of a rental property exceeds the greater of 14 days or 10 percent of the time the home is rented out, then your rental-property deductions are limited to the amount of your rental income for the year. In other words, you can’t claim an overall tax loss from the property.
Too much rent-free use by family and friends could push you over the 14 day/10 percent threshold.
Advice: Charge would-be freeloaders fair-market rent for their visits. One taxpayer learned this lesson the hard way.
New case: A physician said that he was running a bed-and-breakfast on the first floor of his home. But he allowed his daughter and her family to live there for a period of time. Then, he claimed rental income of only $650 and expenses of around $19,000 on his return.
The Tax Court disallowed the loss. Since the daughter wasn’t charged a fair rent for the stay, her use counts towards the physician’s personal use. Thus, he flunked the 14 day/10 percent test. (Lofstrom 125 TC No. 13)
Tip: You don’t necessarily have to charge a relative the same amount as other tenants. In a previous case, the Tax Court allowed a 20 percent reduction on the rental for a close relative, since the relative saved the owner on upkeep and fees. (Bondseil, TC Memo 1983-411)