Considering buying a 2nd home

Financial Planning Tax Strategies
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Hi everyone

I am considering buying a condo in MA. I would rent this unit to a family member at below market rent, due to their low income.

I would likely be cash flow negative while this family member remains in the unit. Upon their eventual evacuation, the unit would require major renovation

My question: would there be any tax benefit to this plan? I assume that I would be able to deduct the mortgage, condo fee, RE taxes from the rent received. I expect the PITI to exceed the total rent.

Would we be able to deduct this loss against our other income?

I appreciate any advice, as always.
-K

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Would we be able to deduct this loss against our other income?

According to this, no:

https://moneydoneright.com/taxes/personal-taxes/below-marketā€¦

Can you charge at the low end of market rent for the property? (Everyplace Iā€™ve been thereā€™s at least some range to what ā€œmarket rentā€ is for a rental.)

Even if you were charging market rent, you may not be able to deduct the loss against other income. If youā€™re a RE agent or income under a certain amount, probably can. Otherwise, no.
https://www.nolo.com/legal-encyclopedia/can-you-deduct-your-ā€¦

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My question: would there be any tax benefit to this plan?

Not really. In fact, itā€™s probably creating more tax issues for you.

I assume that I would be able to deduct the mortgage, condo fee, RE taxes from the rent received.

Your assumption is incorrect. When you purchase a property and rent it to a friend or family member for below market rent, itā€™s considered personal use, not an investment property. So those expenses are not deductible as rental expenses. You would still need to declare the rental income. Per IRS Pub 527:

What is a day of personal use? A day of personal use of a dwelling unit is any day that the unit is used by any of the following persons.
.
.
2. A member of your family or a member of the family of any other person who owns an interest in it, unless the family member uses the dwelling unit as his or her main home and pays a fair rental price. Family includes only your spouse, brothers and sisters, half brothers and half sisters, ancestors (parents, grandparents, etc.), and lineal descendants (children, grandchildren, etc.).
.
.
4. Anyone at less than a fair rental price.

While you didnā€™t specify who the family member was, in any case, since you would be renting for less than a market rate, itā€™s still personal use.

Then you get to the part of Pub 527 where it talks about deducting rental expenses:

Not used as a home. If you use a dwelling unit for personal purposes, but not as a home, report all the rental income in your income. Because you used the dwelling unit for personal purposes, you must divide your expenses between the rental use and the personal use as described earlier in this chapter under Dividing Expenses. The expenses for personal use arenā€™t deductible as rental expenses.

Since 100% of the use of the property would be considered personal under the scenario you described, 100% of the expenses would be personal, and therefore, not deductible as rental expenses.

I would strongly suggest that you consult a tax professional before making any purchase with the intent of renting it at a below market rate. Under current law, as a second home, you may be able to deduct the mortgage interest and property taxes on Schedule A (subject to the SALT limit on property taxes). The condo fee and cost of insurance would not be deductible.

AJ

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AJ: would be considered personal under the scenario you described

What would be the effect if the OP were able to get the property officially labeled ā€œSection 8ā€ and rent under that label to the relative?
The relative would also have to apply for and be granted Section 8 eligible?

https://en.m.wikipedia.org/wiki/Section_8_(housing)

:thinking:
ralph

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What would be the effect if the OP were able to get the property officially labeled ā€œSection 8ā€ and rent under that label to the relative?
The relative would also have to apply for and be granted Section 8 eligible?

Getting a property eligible to be rented under Section 8 is I think usually pretty easy. Most (all?) jurisdictions I think thereā€™s an inspection required. But my experience is the inspection is not that onerous - things like that thereā€™s a smoke detector.

A renter getting section 8 is much more difficult in my experience.
I think many jurisdictions thereā€™s a waiting list for section 8.

IF the renter could get section 8, then the OP would be renting at market rates to the renter. (Assuming that the section 8 administrator allows it - Iā€™d expect they have rules against someone on section 8 renting from their parents/grandparents/siblings, possibly other relatives too.)
The market rate rent would be partially paid for by a check (or direct deposit) from section 8, and part by the renter (via cash/check/whatever)
Since itā€™d be market rate rent, itā€™s a normal rental and all the normal rules apply.

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Also from what I know of section 8 (which isnā€™t much) there is a minimum occupancy rule of 2 people per bedroom. So youā€™d need 5 people for a 3 bedroom house, 3 for a two bedroom house, etc.

Knew a landlord who bought small houses and loved section 8.

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Also from what I know of section 8 (which isnā€™t much) there is a minimum occupancy rule of 2 people per bedroom. So youā€™d need 5 people for a 3 bedroom house, 3 for a two bedroom house, etc.

I think you could have as few as 3 people in a 3 bedroom home. A single parent with a son and a daughter would need a 3 bedroom home.
But I think a 1 bedroom unit with 1-2 people living in it is a much more common section 8 situation.

Knew a landlord who bought small houses and loved section 8.
Thereā€™s good and bad to it - the good is that the housing authority in my experience pays on the expected schedule and their checks never bounce. And the tenants want to keep their section 8 subsidy, so theyā€™re likely to be very good tenants. The bad is itā€™s a little extra hassle dealing with 2 rent deposits instead of 1.

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What would be the effect if the OP were able to get the property officially labeled ā€œSection 8ā€ and rent under that label to the relative?

Since between the government subsidy and the portion of the rent that the tenant is responsible for, the landlord receives a market rate rent, it would no longer be considered personal use.

The relative would also have to apply for and be granted Section 8 eligible?

Yes, that could be an issue, depending on how low the relativeā€™s income is. In Massachusetts (since thatā€™s where the OP talked about purchasing) https://www.mass.gov/guides/a-guide-to-obtaining-housing-assā€¦

Eligibility is based on gross income. 75 percent of all households selected to receive Section 8 must have incomes within 30 percent of the area median income ($24,800 for a family of four in Boston). 25 percent of Section 8 households can have incomes up to 50 percent of the median ($41,350 for a family of four). In some instances these limits can go as high as 80 percent of median ($66,150 for a family of four in Boston) although very few housing agencies serve households with this income at this limit.

Then you have to go on a long wait list after you apply:

How to apply for Section 8: You may apply to any one of the regional non-profit agencies. If you apply to one of the regional housing agencies, your name will be placed on a statewide Section 8 waiting list maintained by the Department of Housing and Community Development. These waiting lists are quite long. The regional housing agency lists are always open.

So unless the OPā€™s family member was already on a Section 8 housing list, and the OPā€™s rental unit came up for rent when the OPā€™s family member got to the top of the list, itā€™s unlikely that the OP could rent to their family member through Section 8. And that doesnā€™t even consider the possibility that there are self-dealing prohibitions in place to prevent Section 8 landlords from renting to family members.

AJ

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Low income is not sufficient to be able to rent to a family member under section 8.

https://homeguides.sfgate.com/become-section-8-landlord-exteā€¦

You may lease your property to your own extended family through Section 8 only if the arrangement provides a home for a disabled family member.

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Wow. Just wow.

THANK YOU ALL for the informative discussion!

Right now, I am trying to keep this family member housed. They are looking into getting onto the section 8 waitlist as well as low income senior housing wait lists

The thorny thing is that those lists are quite long. They have not been given notice to leave their home (yet), but I am trying to have a plan in place to avoid true homelessness in the future.

One option: I buy the condo. They can not afford market rent. As renting it below market rent makes it ā€˜personal useā€™ (THANK YOU AJ for the clear explanation!), at least the interest will be deductible (thank you, SALT cap. Again.). I am still not sure I am clear on the tax aspect on the actual rent received (I am guessing it would be at my marginal rate-- I have a call in to my accountant)

An alternate option: I could potentially pull funds from retirement account, OR take a HELOC on my home, to provide a (properly and legally structured) mortgage so this person could buy the property. They would have to increase income slightly to afford this new, higher (than their ā€˜rentā€™), mortgage payment. I am guessing their mortgage interest to me would be considered ā€˜incomeā€™

The last option: we tell those selling it (its complicated) that this family member has no intention of moving, and will continue to pay ā€˜rentā€™ and hope the new owners keep this person in place. All the while, we wait for their spot on the low income waitlist to open up

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The last option: we tell those selling it (its complicated) that this family member has no intention of moving, and will continue to pay ā€˜rentā€™ and hope the new owners keep this person in place. All the while, we wait for their spot on the low income waitlist to open up

Missing info - do they have a lease ?

To me, none of your options are good and there are more issues than I can list for each. You may be better off gifting monthly rent temporarily. But whenever any word is in quotes(ā€˜rentā€™), there are usually even more issues than mentioned.

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Youngest is in a very expensive rent area, though not quite to Boston levels. We could provide a mortgage to him to buy a property and his payments to us would be cheaper than renting, particularly if he has a roommate move in to help him pay for it. That roommate could even be us if we find a place with an in-law suite, as we are considering a more nomadic lifestyle and just need a home base near a great city and good airport. His pay isnā€™t bad, but itā€™s useless trying to buy a place there without paying cash.

We considered buying and renting back to him, but not looking to get back into the tax implications of a rentalā€¦they were only touched on here. This way he also has skin in the game and would hopefully rise to the occasion. We have a year before we do more than figure out the area. Want to make sure he loves the job and area as much after a hot summer of humidity.

We got to this point in our thinking after putting down on paper what our goals were:

  1. Help Youngest afford a decent place to live and build equity
  2. Avoid conflict by owning outright where he lives
  3. Avoid tax consequences of owning a rental
  4. Have independent living space for us nearby

Your goals are clearly different, but you could potentially have different options to satisfy your goals. For example, if you can afford to do so, what would be the tax implications of buying the property as a life estate for your elderly relative. Could they ā€œgiftā€ you money each year so that it would not be income? Not enforceable, which makes it a gift, IMO. Could it be a second home for you that they are house sitting for? Maybe draw up a list of goals and submit to the buying and selling a home board or back here, as so many of us are on both boards. Be aware that since they are in MA, if they are on Mass Health, there can be income limitations and you may need to go about this via a trust to avoid their losing Mass Health. We had to do that for a sibling when he inherited a small amount of money from our parents. Many moving pieces.

IP

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A random comment

Resident owned mobile home parks often are cheaper and have lower monthly expenses than a condo. We are considering this for a relative. Since they are resident owned, the increases in monthly expenses are more controlled and there is minimal risk of the park closing.

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Thank you all for the comments!

I use ā€˜rentā€™ in this way as I want to avoid posting anything too specific on a public forum.

WRT mobile home: I have concerns about this personā€™s ability/willingness to maintain the property. In MA, that means ensuring no frozen pipes, etcā€“not to mention lawn care, etc.

inparadise: this is my first encounter with the term ā€˜life estateā€™. I need to research. Thank you.

I do not think they are on Mass Healthā€“the person is collecting social security and Medicare.

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Coming late to the conversationā€¦

  • I have limited Section 8 understanding from a friend that ran numerous rentals. Some cities place restrictions on where Sec 8 housing can be. You canā€™t just declare any place to be Sec 8.

  • If you have the money and the means, buy the condo, let the person stay there, count them as a dependent on tax returns.

  • If you still want to buy the condo and rent it, form an LLC. Might complicate your tax return a little but it does offer some benefits and protection, which varies from state to state.

JLC

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- If you still want to buy the condo and rent it, form an LLC. Might complicate your tax return a little

Probably not. Single owner LLCs just pass through to the ownerā€™s tax return. Because of that, renting the condo at less than a market rent would still be considered personal use, and expenses would not be deductible on Schedule E. Itā€™s the same issue that the OP would have if they didnā€™t form an LLC.

but it does offer some benefits and protection, which varies from state to state.

at a cost to set up and maintain the LLC, which also varies from state to state.

AJ

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- If you have the money and the means, buy the condo, let the person stay there, count them as a dependent on tax returns.

Not so fast. Since this person probably isnā€™t a qualifying child (the OP described this as a family member, but not as a child or sibling), you need to look at whether this is a qualifying relative.

One of the criteria is that a qualifying relative canā€™t have more than $4300 in gross income.

Even if this person were a qualifying relative, the benefit would only be a $500 non-refundable credit.

Ira

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This discussion continues to be quite informative

My accountant DID recommend buying it as LLC. So, if I do go through this purchase, that will be done.

Correct-- this person has more than $4,300 income and is not a child.

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is not a child.

I would point out that itā€™s not just being ā€˜a childā€™, Rather, itā€™s being your child (or grandchild).

AJ

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Some cities place restrictions on where Sec 8 housing can be. You canā€™t just declare any place to be Sec 8.
I am a landlord that took Section 8. I think any housing unit that meets the standards for section 8 can be used for section 8. Thereā€™s certainly neighborhoods where it would not make financial sense for a landlord to do section 8. But thatā€™s because the section 8 administrators have a cap on what theyā€™ll consider acceptable rent in their county/area. I think any city trying to prevent section 8 from being used in their city (or parts of their city) would be setting themselves up for a fair housing lawsuit.

- If you still want to buy the condo and rent it, form an LLC. Might complicate your tax return a little but it does offer some benefits and protection, which varies from state to state.

As the property owner and property manager, I donā€™t think Iā€™d see a benefit from an LLC. If I were completely detached from managing the property, I could see an LLC potentially protecting my other assets from a lawsuit. But IMO if Iā€™m managing the property theyā€™ll sue me for that role as well as owner, so that benefit doesnā€™t exist for me.

About the only thing I can see from an LLC for me is it might provide a little (very little) anonymity about the property ownership. (ex. as the manager I could blame the rent increase on the owners)

But if anyone knows of some other benefit/protection Iā€™d see from an LLC, please speak up - Iā€™m not opposed to it, just donā€™t think Iā€™d benefit from it for it to be worth the $500-$1k that I think Iā€™d have to pay a lawyer for to do it.

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