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• Tax deduction for you
• Tax-free income for Mom and Dad t doesn’t have to be Mom and Dad. The tax-free income can go to your brother or sister, or your best friend. To make this work, you need to have a business reason to travel and stay overnight at the Mom and Dad Hotel. Say you travel to a convention, rent your parents’ guest room for five days, and pay them $1,000 fair rent. You deduct the $1,000 as a business travel expense. Your parents have $1,000 of tax-free income. Sound good? Great, let’s see how you can make this work for you by following three rules. Rule 1: 14-Day Limit on Renting Mom and Dad can rent out a room in their home, or rent their entire house, tax-free if they rent it out for no more than 14days during the year. 1 While the rules are generous in allowing your parents not to include this rental income as taxable income, they can’t offset that income with expenses associated with the rental. If you’re staying with a friend who has an apartment, no problem; he or she can rent out a room in his or her apartment—it doesn’t have to be a privately owned home. If you’re renting from a friend who shares a place with a roommate, the free-rent rule refers to a “dwellingunit.”2 So if your friend and roommate both decide to rent out their rooms during the year, they can do it tax-free for a combined total of only 14 days. Rule 2: More Than 14-Day Personal Use Requirement To obtain any tax-free rent, Mom and Dad must personally use the place they are renting to you for more than 14 days during the year.3 For a primary residence, this isn’t a problem. But for second homes or vacation homes, your rental from Mom and Dad or from your brothers and sisters creates potential trouble. Why? Because the days of your rental (at fair value or not) count as days of personal use for Mom or Dad and for your brothers or sisters.4 If a relative’s vacation home looks like a candidate for the free-rent strategy, don’t use the strategy until after you read Avoid the Big Triple-Tax Whammy When Renting to Relatives. Rule 3: Fair Market Rental Rate When you stay at a commercial hotel, you pay an established commercial rate. So when you stay with Mom and Dad, other family, or friends, you also need to pay a commercial rate, which the IRS refers to as a fair market rental rate. The fair market rental price is the amount of rent someone who is not related to the renter would be willing to pay. Search for rentals in the area, and print a few comparable listings to substantiate the rental rate you are paying Mom and Dad. Forget the Time-Share For this tax-free rent to work with a time-share, Mom and Dad first have to use the time-share for more than 14 days so that it qualifies as a residence. And then they and the other owners of the time-share unit as a group have to rent out the unit for fewer than 15 days.5 It’s highly unlikely that you can achieve the tax-free rental benefit with a time-share. Business Lodging Deduction You face the same rules for documenting and deducting your out-of-town business travel expenses whether you stay at the Grand Hotel or the Hotel de Mom & Dad. • You deduct the cost of business lodging as an ordinary and necessary business expense.6
• You may not deduct personal lodging. (But be alert. There are times when what you think is personal lodging is actually business lodging. That’s a nice benefit. See Tax Tips to Identify Tax-Deductible Travel Days.)
• You must have a receipt or other proof of a lodging expense, regardless of the amount paid.7 (Make sure you get a receipt from Mom and Dad and that you pay the amount by check. You need the receipt to prove the lodging and the canceled check to prove that you paid the money.) Form 1099 Tax law says that when you pay business rents that exceed $600 to an individual during a tax year, you must report the total of those business rents to the IRS.8 Hence, if you pay Mom and Dad more than $600 in rent during any calendar year, you have to give them (and the IRS) a Form 1099.9 Example. Say that during the year you stay at Mom and Dad’s home for 11 nights while visiting on business. Based on evidence, you can prove that Mom and Dad’s guest room is about equal to the motel down the street that rents for $119 a night. If you pay Mom and Dad $119 a night for 11 nights, you may deduct the $1,309 you paid for lodging. Mom and Dad’s Tax Return As a good son or daughter, and as required by IRS regulations, you completed a Form 1099-MISC that told Mom and Dad and the IRS that you paid $1,309 in rent. Now that you have completed and filed the required 1099, IRS computers are looking for that rent amount on Mom and Dad’s tax return. Don’t let Mom and Dad disappoint the IRS. Also, keep this in mind: the IRS does not know that the rent is tax-free until it sees the tax return. Mom and Dad should report the rental income from the Form 1099 on their Schedule E for the year. Then, because the amount is not taxable, they should subtract that amount in the expense section of Schedule E and add a supporting statement: “Taxpayers rented their personal residence for fewer than 15 days during the taxable year. The rental income was reported on a 1099 and is thus reported as income on Schedule E. That rent is exempt from taxation under IRC Section 280A(g) and is thus removed with the offsetting expense entry on that same Schedule E.” Sales and/or Occupancy Taxes All the rules above apply for federal income tax purposes. But there’s a tax collector other than the income tax guy who also has an interest in short-term occupancy. This tax collector specializes in occupancy and sales taxes on hotels, short-term rentals of beach and ski properties, and transient lodging such as that arranged by Airbnb, Homeaway, and VRBO. Because you get the business deduction for your travel, you should have Mom or Dad or other host add the occupancy tax to your lodging bill. Mom and Dad will pay the tax collector but get no deduction for it because the income is tax-free. You might think that the local jurisdiction is unlikely to know Mom and Dad are renting out their home for a few days to a family member. We prefer to think of the occupancy tax this way: paying the occupancy tax adds to proof of the room’s rental. Observation. To overcome the occupancy tax problem, Airbnb collects and remits the taxes in many of the locales where it has hosts.10 Takeaways If your business travel takes you to where friends or family live and you would stay with them for free, change tactics and rent their guest room. As you now know, you can do this. You deduct your business travel lodging, and your friends and family can receive the rent as tax-free income. Remember the three easy rules: Rent for fewer than 15 days. To qualify for the tax-free rental income, the home must be rented for fewer than 15 days during the year. Use the property as a home for more than 14 days a year. The home must be used by the owner as a residence for more than 14 days for it to qualify as a residence eligible for the tax-free rent. Charge fair market rent. Make sure your family or friends document that the rent paid is fair market rent. Fair rent is the rental rate usual for the area, time of year, and type of place. When you pay related parties, the IRS has fair rent top of mind in its list of questions. The 1099 paperwork is easy. Do it. The occupancy tax, if any, may prove more difficult, but it does add proof of the rental, and proof is valuable when having discussions with the IRS about tax deductions.

We encourage you to connect with your Johnson Nathaniel advisor regarding how the above may affect your specific situation. Connect with our team The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments. RELATED SECTIONS Tax
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