Is there was any advantage to buying your parents’ home and then renting it back to them?
Is there was any advantage to buying your parents’ home and then renting it back to them? (Answered by Joe Librandi, Librandi Consulting and Tax Preparation)
"Your first thought might be that this sounds like an incredibly complex approach to saving tax dollars, not to mention the ever-present PIA (pain in the ass) factor. But read on, it’s not as tough as it sounds and the tax savings for both of you could be substantial.
Let’s say that your (aging) parents live in a home that has soared in value, but they're no longer reaping any of the homeownership tax breaks during their retirement years. Sound familiar?
The good news is that with one stroke of the pen, both you and your parents can win: They'd gain instant access to their home equity (without having to move) and you'd pick up some generous new tax deductions.
How? Buy your parents' house, and then rent it back to them-at the going rate (with going rate being the operative word).
Under current home-ownership rules, the fact that you own your home and they own theirs means that your combined family unit (you plus them) is overpaying the IRS.
Your parents' mortgage is either paid off or the payments represent mostly principal at this point, with little or no interest to claim on a Schedule A. And, as I’ve mentioned to you during your prep appointments, most of my clients who file a Schedule A (Itemized deductions) are able to do so because of deductible mortgage interest. Unreimbursed medical, property taxes, charitable contributions and employee business deductions are mostly (but not always – you may be an extremely charitable person) the icing on the cake.
More than likely, your parents are no longer taking mortgage interest deductions, or, if they are, those deductions don't provide much tax savings because of their low tax bracket. In fact, many retirees take the standard deduction rather than itemizing.
Here are two good reasons for your parents to opt into this plan:
1. It puts cash in their pockets without having to refinance or get a home equity loan (thereby avoiding paying that interest).
2. It allows them to put their money into safer investments than the real estate market.
Transferring the house: To avoid tax complications, pay a fair price for the home. And be sure to support the buying price with newspaper listings of similar homes. Over the years. Over the past 24 years, I’ve occasionally defended some of you in front of the IRS. In the few cases where we didn’t get the decision we wanted, it was mostly due to your not being able to provide the necessary documentation. In this instance, an appraisal by a licensed real estate agent, comparing your parents’ home to at least three other homes of the same type would be money well spent. Also, due to the fact that we can’t depreciate land, make sure the appraisal allocates the overall value of the property into two separate entities: the price paid between the depreciable structure and the nondepreciable land.
The next step is for both parties to enter into a lease agreement that is firmly rooted in the above-noted fair rental value documentation. In English, that means you can’t rent a house appraised at $ 250,000 to your parents for $ 100 a month. There can be no appearance of favoritism if you want this thing to fly.
The courts have said that landlords can reduce their fair-market rent by 20% when renting to relatives. That lower rent reflects the savings in maintenance and management costs.
However, if you set the rent too low; the IRS might say the rental home is really for your personal use. In that case, your deductions might be limited to mortgage interest and property tax, the same as if you owned a vacation home.
Once you own your parents' house, you're entitled to reap the tax benefits of owning rental property. That includes taking write-offs for operating expenses, such as utilities, maintenance, insurance, repairs and supplies.
You also can claim depreciation deductions for the home, but, as noted above, you can't depreciate the cost of the property apportioned to land.
You can use these deductions to offset the rental income received from your parents. Keep in mind any allowable tax loss will phase out for people with adjusted gross incomes between $100,000 and $150,000, so this won’t work for everyone. You can take any suspended losses when you sell the house.
Once you own the house, you may be able to write off the occasional travel expenses that you incur when visiting the house (your rental investment).
Eventually, your parents won't be able to live in the house. Then, you can sell it, rent it to another tenant or move in. If you move in and make it your principal residence for at least two years, you can sell it and shelter another $250,000 or $500,000 worth of capital gains.
Now your parents have a (hopefully) sizable nest-egg to live off and you have some nice tax deductions. Everybody wins."
Librandi Consulting and Tax Preparation
http://www.freewebs.com/librandiconsulting/