In fact, if your parents claim the standard deduction instead of itemizing, they get no income tax benefit at all from home ownership.
Strategy: Consider buying your parents’ home. Then, lease it back to them at the going rate. That way, they can tap into the built-up home equity without moving away.
And you’re able to reap the tax rewards of renting the house.
For starters, the sale can put some much-needed cash into your parents’ pockets. And little or no income tax will be due on the sale, thanks to the giant home-sale exclusion. The tax law allows an individual to exclude tax on the first $250,000 of gain from the sale of a principal residence; $500,000 for a married couple filing jointly.
To avoid potential gift-tax complications, pay a fair price for the home. Save newspaper clippings that support prices for comparable homes in the area. Now may be a good time to strike a deal, due to a relatively soft market.
As the home’s legal owner, you’re entitled to the usual tax breaks of owning rental property. Example: You can claim deductions for operating expenses, insurance, repairs and supplies. Furthermore, when you visit the rental property, you can write off some or all of the travel expenses.
Of course, you can also claim depreciation deductions for the home. But you can’t write off the property’s cost that is attributable to land.
Strategy: Secure an appraisal allocating the price paid between the depreciable structure and non-depreciable land. If you’re including furnishings and appliances, allocate those costs, too. You can write off those objects over a shorter period of time.
All of those deductions can offset the rental income you’ll receive from your parents, which reduces the tax you’ll owe on the income.
The deduction may even exceed your rental income, thereby generating an annual tax loss. That could occur even if you’re breaking even or showing a positive cash flow. But here’s one potential downside: You must treat the loss as a passive-activity loss (PAL).
PALs aren’t so taxpayer-friendly
With a PAL, you may not receive the full tax benefit of the loss.
Here’s how it works: You generally can deduct passive losses only up to the amount of income from other passive activities. But, if your adjusted gross income (AGI) is less than $100,000, you can still deduct passive rental real estate losses of up to $25,000 a year. Once your AGI exceeds the $100,000 mark, your ability to deduct those losses diminishes, dwindling to zero when your AGI reaches $150,000.
If you can’t deduct all the losses because of the PAL limits, you will be able to deduct the suspended losses when you sell the home or it begins to produce positive taxable income.
Leave a paper trail
For you to claim the tax benefits of owning rental property, your parents must pay you a fair rent.
Goods news: The courts have said that landlords can reduce the fair-market rental they charge by 20 percent when renting to relatives. That’s supposed to reflect the savings on maintenance and .
But if you set the rent unreasonably low, the IRS could consider the rental as personal use. In that case, your deductions may be limited to mortgage and property taxes, as with a vacation home.
Strategy: Lock in deductions on the dotted line. Have your parents sign a lease, the same as you would require for another tenant.
Eventually, your parents may decide to move out, perhaps due to their physical limitations. At that point, you can rent the place to a new tenant, sell it or even move in yourself.
Tip: If you live in the home for at least two years, you can also qualify for the $250,000/$500,000 home-sale exclusion. Between you and your parents, you can pull down up to $1 million in tax-free profits!
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