Renting to Family Member Below Market Value - Tax Implications?

Thanks for this explanation. Does this mean I'll pay more in taxes overall than if I charged him market rate? And if I ever decide to convert it back to a regular rental at market rates, would I be able to start claiming depreciation again, or is that permanently lost?

You will likely pay more in taxes by renting below market rate because you can't deduct expenses against the rental income other than mortgage interest and property taxes on Schedule A (and only if you itemize). If you charged market rate, you could deduct all eligible rental expenses including depreciation, repairs, insurance, etc., against the full rental income. If you convert it back to a market-rate rental property in the future, you can indeed begin treating it as a rental property again for tax purposes. You would resume taking depreciation, but you'd need to adjust your depreciation schedule based on the property's depreciable value and the time it's been owned. The depreciation isn't permanently lost, but the calculation becomes more complex since you've had periods of rental use and personal use.

Did they help with figuring out if there's any way to still deduct any expenses? Like if my family member is paying 70% of market rate, can I deduct 70% of expenses or is it all or nothing with the IRS?

I'm skeptical about these online tools. Did they actually provide any information you couldn't find on the IRS website? And how complicated was the process to upload all your documentation?

They did clarify the expense situation - it's essentially all or nothing with the IRS. If you're renting below fair market value to a relative, you can't take the rental expense deductions on Schedule E regardless of what percentage of market rate they're paying. The only deductions you get are the mortgage interest and property taxes on Schedule A if you itemize. Regarding your question about online tools versus the IRS website - the IRS information is certainly available but it's spread across different publications and can be hard to interpret. What I found valuable was having everything consolidated and explained in plain English specifically for my situation. The upload process was pretty straightforward - I just took pictures of my documents with my phone and uploaded them. Took maybe 5 minutes total.

How does this service actually work? Do they just call the IRS for you? I don't understand how they can get through when regular people can't.

This sounds like BS honestly. There's no way to "skip the line" with the IRS. I bet they just put you on hold exactly like you'd be if you called yourself. Can't believe people pay for this.

They use an automated system that continually calls the IRS and navigates the phone tree until it gets through to a representative, then it calls you to connect. It's basically doing what you would do manually but with technology that can keep trying when all lines are busy. I had the same skepticism initially. I mean, if it was that easy, why wouldn't everyone do it? But it's not about "skipping the line" - it's about having a system that persistently tries to get through rather than you having to manually redial and go through the whole phone tree repeatedly. The fact is that most people give up after a few attempts, but their system doesn't.

For option 1, wouldn't that be considered some kind of tax fraud though? If you're charging market rate on paper but then giving the money back as a "gift"? Seems like the IRS would see right through that.

It's actually not fraud if done properly. You'd need to charge full market rent, deposit the full amount, then separately write a gift check. The rental would be documented with a proper lease at market rate, and you'd report all income and expenses normally on Schedule E. The gift portion is completely separate from the rental arrangement. Just make sure the gift stays under the annual gift tax exclusion amount ($17,000 per recipient for 2024) to avoid filing gift tax returns. And maintain proper documentation for both transactions - don't link them together contractually in any way.

That's a really good point. So what forms would need to be filed to show this conversion? And does this mean the original poster might actually owe more taxes than they thought?

@Brian Downey brings up a crucial point that could significantly impact the tax situation. When converting from rental to personal use, you typically need to file Form 4797 Sales (of Business Property to) report any gain or loss from the conversion. The conversion is treated as if you sold "the" property to yourself at fair market value on the date of conversion. If the FMV exceeds your adjusted basis original (cost minus accumulated depreciation ,)you ll'have a taxable gain. Part of this gain may be subject to depreciation recapture at ordinary income rates up (to 25% for real estate ,)while any remaining gain would be capital gain. @Jacinda Yu - yes, this could mean significantly more taxes owed, especially if the property has appreciated and substantial depreciation was claimed in prior years. The original poster should definitely consult a tax professional before proceeding, as this conversion has major tax implications beyond just how to report the below-market rent.

This is really helpful, especially the point about TaxSlayer compatibility. I'm new to dealing with rental property tax issues, so I'm wondering - when you mention keeping detailed records of the varying monthly payments, should I also document why the payments varied? My brother sometimes paid less when he had unexpected expenses, and I'm not sure if the IRS would want to see that justification or if just recording the actual amounts received is sufficient. Also, regarding the formal lease agreement you mentioned - would having a written lease at the reduced rate actually help with the IRS, or is it more for my own protection? I've been operating on a handshake agreement so far, but if it could make a difference for tax purposes, I'd definitely consider drafting something up.

@StarSeeker Great questions! For the varying payments, you don't need to document the reasons why payments varied - just keep accurate records of the actual amounts and dates received. The IRS cares about the income you actually received, not the personal circumstances behind payment variations. Simple records like a spreadsheet showing "January: $1,150, February: $1,200" etc. would be sufficient. Regarding the lease agreement - while it won't change the tax classification (it's still personal use property regardless), a written lease can help establish that this is a legitimate business arrangement rather than just informal family help. This could be valuable if you're ever audited, as it shows you treated this as a rental arrangement with defined terms, even at below-market rates. The lease should specify the monthly rent amount (even if reduced), payment due dates, and basic tenant responsibilities. Just make sure the rent specified matches what you're actually collecting and reporting as income - don't put fair market value in the lease if you're not charging that amount. @Levi Parker is absolutely right about documentation being crucial. The IRS tends to scrutinize family rental arrangements more closely, so having proper records helps demonstrate legitimacy.

@Paolo Longo You re'absolutely right to be concerned about the depreciation recapture issue - this is a major consideration that could significantly impact your tax liability. The conversion from rental to personal use is indeed treated as a taxable event by the IRS. I haven t'personally gone through this exact conversion, but I ve'seen similar situations where the recapture taxes ended up being substantial, especially if the property has appreciated significantly since you started renting it out. The recapture is calculated on the depreciation you ve'claimed over the past 3 years, potentially taxed at up to 25% for real estate. Your instinct about considering alternatives might be wise - raising the rent to fair market value would allow you to continue treating it as a legitimate rental property and avoid any conversion issues. Alternatively, if you stop collecting rent entirely and let your sister live there rent-free, it becomes clearly personal use without the complications of below-market rental income. I d'strongly recommend consulting with a tax professional who can run the numbers on potential recapture liability versus the ongoing tax benefits of different arrangements. The upfront cost of professional advice could save you thousands in unexpected taxes. Which AI tax tool did you end up using? I m'curious since several have been mentioned in this thread and it sounds like you had a good experience with the explanations.

This is such a smart approach! I'm curious about the logistics of keeping the rental and gift transactions separate - do you use different bank accounts or just make sure the timing is clearly separated? Also, when you say "proper documentation" for the gift checks, what exactly does that entail? I'm wondering if you write "gift" in the memo line or if there's more formal documentation required to keep everything above board with the IRS. I'm in a similar situation and this seems like it could be the perfect solution to avoid the depreciation recapture headache while still helping out my family member.

@Carmen Lopez Great questions! For the logistics, I keep everything completely separate. The rent goes into my regular checking account where I handle all my rental property business, and I write the gift checks from that same account but several days later never (on the same day .)For documentation, I do write gift "in" the memo line of the checks, and I also keep a simple spreadsheet tracking the gift amounts and dates for my records. My CPA advised that while you don t'need to file any special forms as long as you stay under the annual exclusion $17,000 (for 2024 ,)it s'good practice to maintain clear records showing the gifts are separate from the rental arrangement. The key thing my CPA emphasized is that the lease agreement can t'reference the gifts at all - it needs to be a legitimate market-rate lease that stands on its own. The gifts are a completely separate family transaction. I actually waited about 3 months after we signed the new lease before I started making the monthly gifts, just to make sure there was clear separation between the two arrangements. @TillyCombatwarrior s'approach has saved me thousands in potential recapture taxes and I still get all the rental property deductions. Definitely worth exploring if you re'in a similar situation!