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Buy Your Parent’s Home, Then Rent It back To Them?

March 4, 2011

Both of my parents passed away (in the same year) about 5 years ago. Dad died first of cancer in April then my Mom went in for a heart valve replacement in October and died the next day (apparently her heart was worse than they thought). That was a tough year for us kids. After Dad died we became very involved in the well-being of our Mom…not that she wanted us to, but with her aging and being alone we tried to make life easier for her. There are tax breaks that can help aging parents such a buying your parents’ home and renting it back to them. Sounds odd, but here is the deal.

Say your aging parents live in a home that has appreciated in value, but they’re no longer reaping any of the homeownership tax breaks during their retirement years. Sound familiar?  Good news: with one stroke of the pen, both you and your parents can win. They’d gain instant access to their home equity (without moving) and you’d pick up some generous tax deductions. How?  Buy your parents’ house, and then rent it back to them – at the going rate. Reasons for the sale/leaseback: under the current homeownership set-up, your combined family unit is overpaying the IRS. Your parents’ mortgage is either paid off or the payments represent mostly principal at this point. Even if they still take interest deductions, your parents’ tax bracket might be low in retirement, so those deductions don’t provide much tax savings. In fact, many retirees take the standard deduction rather than itemizing. Here are two reasons for your parents to opt into this plan.

  1. It puts cash in their pockets without them having to refinance or dip into a home equity loan.
  2. It allows them to put their money into safer investments than the real estate market.

Transferring the house:  to avoid gift tax complications pay a fair price for the home. Support the buying price with a qualified and independent appraisal. Then both sides should enter into a lease at a fair rental value. One benefit: Courts have said that landlords can reduce their fair-market rent by 20% when renting to relatives. That lower rents reflects the savings in maintenance and management costs. But don’t set the rent too low; the IRS might say the rental home is really for your personal use. In that case, your deductions might be limited to mortgage interest and property tax, the same as if you owned a  vacation home. Once you own your parents’ house you are entitled to reap the tax benefits of owning rental property. That includes taking write-offs for operating expenses, such as utilities, maintenance, insurance, repairs and supplies. you also can claim depreciation deductions for the home, but you can’t depreciate the cost of the property apportioned to land. So obtain an appraisal allocating the price paid between the appreciable structure and the non despicable land. You can use these deductions to offset the rental income received from your parents. Any allowable tax loss will phase out for people with adjusted gross incomes between $100,000 and $150,000. You can take any suspended losses when you sell the house. Bonus benefit: Once you own the house, you may be able to write off occasional travel expenses you incur when visiting the house (your rental investment).

Eventually, your parents won’t be able to live in the house. Then, you can sell it, rent it to another tenant or move in. If you move in and make it your principal residence for a least two years, you can sell it and shelter another $250,000 or $500,000 worth of capital gains: a true tax bonanza! And that is what we do here at GAI (www.gunwel.com), get you those true tax bonanzas! Give us a call at 212-979-6830 or stop by for a visit! You work hard for you money, let Gunwel Tax & Bookkeeping work smart to help you keep it. See you soon!

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