- Tax deduction for you
- Tax-free income for Mom and Dad
It doesn’t have to be Mom and Dad. The tax-free income can go to your brother or sister, or your best friend.
To make this work, you need to have a business reason to travel and stay overnight at the Mom and Dad Hotel.
Say you travel to a convention, rent your parents’ guest room for five days, and pay them $1,000 fair rent. You deduct the $1,000 as a business travel expense. Your parents have $1,000 of tax-free income.
Sound good? Great—let’s see how you can make this work for you by following three rules.
Rule 1: 14-Day Limit on Renting
Mom and Dad can rent out a room in their home or rent their entire house (tax-free) if they rent it out for no more than 14 days during the year. While the rules are generous in allowing your parents not to include this rental income as taxable income, they can’t offset that income with expenses associated with the rental.
Rule 2: More Than 14-Day Personal Use Requirement
To obtain any tax-free rent, Mom and Dad must personally use the place they rent to you for more than 14 days during the year. For a primary residence, this isn’t a problem.
But for second homes or vacation homes, your rental from Mom and Dad or your brothers and sisters creates potential trouble. Why? Because the days of your rental (at fair value or not) count as days of personal use for Mom or Dad and for your brothers or sisters.
Rule 3: Fair Market Rental Rate
When you stay at a commercial hotel, you pay an established commercial rate. So when you stay with Mom and Dad, other family, or friends, you also need to pay a commercial rate, which the IRS refers to as a fair market rental rate.
Tax law says that when you pay business rents that exceed $600 to an individual during a tax year, you must report the total of those business rents to the IRS. Hence, if you pay Mom and Dad more than $600 in rent during any calendar year, you have to give them (and the IRS) a Form 1099.
Mom and Dad’s Tax Return
Mom and Dad should report the rental income from the Form 1099 on their Schedule E for the year.
Then, because the amount is not taxable, they should subtract that amount in the expense section of Schedule E and add a supporting statement such as the following:
Taxpayers rented their personal residence for fewer than 15 days during the taxable year. The rental income was reported on a 1099 and is thus reported as income on Schedule E. That rent is exempt from taxation under IRC Section 280A(g) and is thus removed with the offsetting expense entry on that same Schedule E.
If you want to discuss this strategy, please call me on my direct line at 804-625-8061 or schedule an advisory session on my calendar.