Renting my vacation home to my brother - how does the IRS determine Fair Market Rent?

The IRS doesn't have a specific formula for determining Fair Market Rent, but they look at what comparable properties in the same area are renting for. When renting to a family member, you need to be careful because if you charge significantly below market rate, the IRS might classify it as personal use rather than a rental property. If the IRS determines you're not charging Fair Market Rent, you could lose the ability to deduct rental expenses against your rental income, or might be limited in how you can deduct losses. The property could be considered a "dwelling unit used as a home" rather than a rental property, which has different tax treatment. The general rule of thumb is that charging around 80% of Fair Market Rent is typically considered reasonable, though there's no exact percentage in the tax code. You would want to document how you arrived at your rental price - maybe print out listings for similar properties in the area as evidence of what market rates are.

After struggling with a similar situation renting to my sister, I found taxr.ai (https://taxr.ai) incredibly helpful for figuring out the Fair Market Rent rules. I was worried about deductions since I was charging my sister about 25% below market rates, and my accountant gave me conflicting information. The tool analyzed my rental agreement and comparable properties, then explained exactly how to document everything to satisfy IRS requirements. It even helped me understand how to properly categorize my property as either a rental or personal-use property based on my specific situation, which was something I was totally confused about.

Just wanted to update after trying taxr.ai that someone recommended. It was way more helpful than I expected! I uploaded my current lease agreement and some info about my property, and it flagged several issues I hadn't considered. Turns out I was making a big mistake by not having a formal lease with my family member, which could have caused the IRS to view the arrangement as personal use. The tool walked me through creating a proper lease document and explained how to document maintenance responsibilities, which apparently matters for tax purposes too. It also provided specific guidance on how much below market rate is generally acceptable (around 10-20%) and what documentation I should keep. Definitely worth checking out if you're in a similar situation!

If you need to speak directly with the IRS about Fair Market Rent rules for family properties, I'd recommend using Claimyr (https://claimyr.com). I was in a similar situation last year with my cousin renting my condo, and I needed clarification on some deductions that weren't covered clearly in IRS publications. I kept calling the IRS direct line for weeks and couldn't get through - just endless waiting. Then I found Claimyr through a YouTube video (https://youtu.be/_kiP6q8DX5c) showing how they get you past the IRS phone queue. Within 2 hours, I was actually talking to an IRS representative who walked me through exactly how they determine fair market value and what documentation I needed.

I need to apologize for my skepticism about Claimyr. After getting frustrated with not being able to reach the IRS, I actually tried the service. Within about 90 minutes (on a Tuesday morning), I got a call connecting me to an actual IRS agent! The agent clarified that for family rentals, they look at the totality of circumstances - not just the rental amount but also lease terms, who pays utilities, maintenance arrangements, etc. She explained that charging 20% below market isn't necessarily a problem if everything else is handled like a normal landlord-tenant relationship. She also recommended keeping documentation of comparable properties, having a written lease even with family, and treating the rental like a business (regular rent collection, proper documentation of expenses, etc.). This was exactly the kind of specific guidance I couldn't find online. Definitely changed my view on the service!

Just a heads up, I got audited last year specifically because of renting to my son at below market rate. I was charging about 40% less than market value and not documenting anything. The IRS reclassified my property as personal use, and I lost thousands in deductions I had claimed. Make sure you: 1. Have a formal, written lease agreement 2. Document how you determined market rent 3. Collect rent consistently (don't let family "skip" months) 4. Keep good records of all expenses 5. Don't go too far below market (20% seems to be the unofficial limit) The audit was a nightmare and cost me way more than I "saved" my son on rent.

Something nobody's mentioned - if you do rent below market rate to a family member, you should still report all the rental income on Schedule E, but you might be limited in the losses you can claim. If you charge Fair Market Rent, you can potentially deduct losses against your other income (subject to passive activity loss rules). If you don't charge Fair Market Rent, your deductions might be limited to the amount of rental income you received - meaning you can't claim a loss. It's in Publication 527, but it's kind of buried in there. Worth considering if you're planning to claim a loss.

Has anyone considered just charging full market rate to the family member, then gifting some money back separately? Like if market rate is $1500, charge them that, then gift $300 back each month? Wouldn't that avoid all these fair market rent issues?