If you rent a home to a family member, your taxes could majorly be affected by your answers to three questions.
1. Do you charge rent?
If yes, go on to 2.
If not, your taxes may be simpler but you can take fewer deductions for this home. Of course you can deduct the real estate taxes and home mortgage interest (if this is a qualified second home) if you itemize your deductions. But there are no rental deductions available if you do not charge rent.
2. What is the fair rental value?
Fair rental value for a home can be learned by checking out the rent for other homes that are of the same size, location, and condition. If research reveals you are charging rent comparable to the other homes, you know this home is rented at fair rental value and you probably have a profit motive. Keep the research materials used, such as newspaper or online ads, with your other tax records.
3. Is the rent you charge fair rental value?
If yes, you must report all rental income and expenses on Schedule E (Form 1040). Your rental expenses include things such as repairs, insurance, utilities, homeowner’s association fees, and depreciation. The expenses you paid in excess of your rental income may be limited by the passive activity loss limitations, but they can carry forward for an unlimited number of years.
If not, you fall under “not rented” for profit rules. In this case, the rental income is reported on line 21 of your return as “Other Income” instead of filing Schedule E. The mortgage interest and real estate taxes paid may be deducted in full on Schedule A (Form 1040) if the rental home is a qualified second home. All other rental expenses are included on Schedule A as miscellaneous deductions if you itemize, and subject to the 2% adjusted gross income threshold. These expenses are also limited by the rental income you received this year, but the excess is not carried forward to next year.