Personal Finance: Ask the Experts

Get advice on money matters from The Bee's Claudia Buck and a panel of local experts

March 18, 2013
Is home a rental or a second home?

Q. My son lost his house to foreclosure in 2010. My wife and I purchased a foreclosed home in Sep 2012 for him and family to live in. We are sole property owners on the deed with my son making the mortgage, utility payments, closing cost repayment with additional money for needed repairs. I made repairs and improvements on the property in 2012. When his credit is re-established, our intent is for him to refinance the mortgage balance and purchase the house.
For tax purposes, since we bought the house, is this a rental property or a second home? If it is a rental property, I am not asking fair market rent for this property. However, I want to receive tax benefits for closing costs, taxes, insurance, improvements, etc. As long as he continues payment of all financial costs, we do not consider this home a money making investment, but an investment in my son's future. Please advise.
Frank
Sacramento, CA

A. Based on your statement that your son is not paying fair rental value, the home is not a rental for tax purposes. In order for a property to be a rental, with the corresponding tax treatment, it must be rented at fair rental value. Use by a family member at below market rent is considered personal use by the owner. The "vacation home" rules of Internal Revenue Code Section 280A limit the deduction of maintenance expenses and depreciation to the rental income reduced by otherwise deductible expenses (mortgage interest, property taxes and casualty losses). Don't forget to report the rental income.

You may want to be sure that your son is not paying fair rental value by determining what market rent would be for the residence and comparing that to what your son is paying on a monthly basis. The Tax Court allowed a discount from market rent in determining fair rental value to a relative on the argument that the relative was a reliable tenant which reduced the owner's potential costs. See Bindseil, TC Memo 1983-411 where the taxpayer successfully argued that a discount from third party market rent should apply for rental to a relative based on reduced costs. The vacation home expense limitations do not apply to a home rented at fair rental value to a relative who uses it for their principal residence. In that case, it would be treated as a rental for tax purposes.

Closing costs related to the purchase of the property are added to the cost basis for the purposes of calculating depreciation and gain or loss from the disposition. Similarly, improvements to the property are added to the "tax basis." If the property is ultimately sold at a gain, the gain is taxable. If a personal use residence is sold at a loss, the loss is nondeductible. If a rental property is sold to a relative at a loss, the loss is nondeductible (per Internal Revenue Code Section 267(a)).

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Meet Our Financial Experts

Claudia Buck

Claudia Buck is The Sacramento Bee's personal finance columnist. Read all her columns here. Contact her at cbuck@sacbee.com

Terri Carpenter

Terri Carpenter offers advice on job hunting, retraining and career counseling. Carpenter works at Sacramento Works Inc., the career and job training arm of the Sacramento Employment and Training Agency (SETA). With 15 years in the field, she has hands-on experience with everyone from first-time job seekers to career professionals seeking advice after a layoff or looking for a mid-career change. Ask her a question.

Carlena Tapella

Carlena Tapella is a partner in the law firm of Webb & Tapella Law Corp. in Sacramento. The firm specializes in estate planning and probate, such as estates, trusts, conservatorships and litigation. She is a past president of the Sacramento County Bar Association's Estate Planning & Probate Section. Ask her a question.

Kimberly Foss

Kimberly Foss, certified financial planner, is the founder of Empyrion Wealth Management in Roseville. With nearly 30 years in the financial industry, her clients include women in transition, small business owners, retirees and "pre-retirees." Ask her a question.

Jesse Weller

Gregory Burke, a CPA and tax expert with John Waddell & Co. in Sacramento since 1984, worked as an IRS tax auditor for six years. He’s a past chairman of the California Society of CPAs. Ask him a question.

Daniel Tahara

Daniel Tahara takes your questions about California taxes. Tahara, a spokesman for the state Franchise Tax Board, has 10 years of experience as a tax auditor. Ask him a question.



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