Q. Last year I relocated to North Carolina, where I still work for the same company I worked for in New Jersey. Instead of selling my home, my nephew and his wife rented it from me. We agreed they would pay the property taxes and $600 a month. I haven’t received a dime. Do I have any recourse to claim income losses on the property?
– Nice Uncle
A. Renting to family can be tricky. While it sounds like your heart was in the right place, when things do not go as planned, it can be difficult.
To answer your question, let’s focus on breaking down rental activity into two components: income and deductions.
The monthly rent that your nephew and his wife agreed to pay is considered income to you when received, said Chadderdon O’Brien, a certified financial planner with RegentAtlantic in Morristown.
Let’s assume your annual property taxes are $7,200. Based on this amount, plus the $600 additional monthly amount they agreed to pay, their monthly rent equals $1,200. For a full year, annual rent and your reportable income is $14,400.
On the deduction side, items like mortgage interest, property tax, operating expenses, depreciation and repairs can all generally be claimed. For simplicity, let’s assume the only deduction you have is your property tax. Reducing your $14,400 of income for the $7,200 of property tax paid, you are left with net rental income of $7,200.
However, you said your nephew and his wife have never made any payments. Since the monthly rental payment is income to you, if your tenants are not paying rent you are not required to claim that income. Back to our example above, if you have no rental income but $7,200 of deductions, you have a net rental loss of $7,200.
Since you are not in the real estate business, the IRS classifies your rental activity as “passive” and provides you with a set of passive activity loss rules citing how you can use your rental loss.
You cannot use your rental loss of $7,200 to reduce your income from your normal wages. The loss, however, does not go away and can be carried forward on future year’s tax returns.
Depending on if you maintain the New Jersey home as a rental property, this loss could come in handy if you ever decide to sell the property. It would be a good idea to strategize with your accountant on how this loss specifically impacts the taxability of the sale of your home, if at all.
IRS Publication 527 provides more detail on how income, deductions and losses can be claimed for rental properties.
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