Tax deductions for self-rental arrangement in our primary residence - legal strategy?

This is a common strategy but there are several important considerations before proceeding. The IRS scrutinizes self-rental arrangements closely, especially for primary residences. First, you must legitimately qualify as a real estate professional (750+ hours annually in real estate activities, with more time spent on real estate than any other occupation). Simply having a license isn't enough - you need documented hours. Second, the "self-rental" rule under IRC 469 can recharacterize rental income as non-passive, while keeping losses passive. This asymmetry often surprises taxpayers. Third, you'll need proper documentation - a legitimate lease agreement, separate accounts, property management records, and proof you're paying fair market rent. The LLC should be treated as a separate entity with its own bank accounts, insurance, etc. Finally, consider long-term implications: you'll lose the capital gains exclusion ($500k for married couples) when selling your primary residence since it's now an investment property, and you'll have depreciation recapture issues.

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I see a lot of comments about the tax implications but nobody's mentioned how frustrating it is trying to get answers directly from the IRS on complex scenarios like this. I've been trying for WEEKS to get someone on the phone who could answer detailed questions about self-rental rules and material participation. After wasting hours on hold, I found https://claimyr.com and you can see how it works here: https://youtu.be/_kiP6q8DX5c - it's a service that basically waits on hold with the IRS for you and calls you when an actual agent is on the line. I was skeptical but decided to try it when I was desperate to get clarification on some real estate professional status questions. It actually worked! Got a call back with an IRS representative on the line about 2 hours later, which saved me from sitting on hold myself. The agent was able to clarify several points about documentation requirements for material participation that my CPA wasn't even clear about.

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Be VERY careful with this strategy! I tried something similar in 2023 and ended up being audited. The issue wasn't the self-rental itself but the "economic substance" of the arrangement. The IRS argued that the transaction lacked a legitimate business purpose beyond tax avoidance. Some things that tripped me up: - Not having proper insurance (needs to be landlord insurance, not homeowner's) - Using personal accounts for some property expenses - Not having a formal lease with all proper terms - Not being able to prove fair market rent (you need comparable properties) The audit cost me more than I ever would have saved, plus I had to amend three years of returns. Just be absolutely certain your documentation is bulletproof if you go this route.

Has anyone considered the insurance implications of this arrangement? Most homeowner's policies won't cover claims if you're technically renting from an LLC that you own. You'd need a landlord policy for the LLC and a renter's policy for yourselves. Also, what about mortgage considerations? Many residential mortgages have occupancy clauses requiring the borrower to occupy the property. If the LLC takes the mortgage but doesn't occupy it, you might be violating the terms.