Here’s a familiar scenario: your parents (or one parent) want to stay in their house, where they’re comfortable, but they also need to cash in their home equity for a comfortable retirement lifestyle.
You can help by buying your parents’ home, then renting it back to them. Both parties stand to gain, thanks to the tax code. Chances are, your parents aren’t getting many tax advantages from home ownership:
After living in the house for so many years the mortgage may be paid off, or nearly so. With a low mortgage or no mortgage, they get little or no deductions for mortgage interest.
Even if they pay mortgage interest, the deduction may not be worth much, if their retirement income puts them into a low tax bracket. The same goes for their property tax deductions.
Many seniors take a standard deduction rather than itemize. If your parents are in this category, they’re getting no tax benefit from home ownership.
On the other hand, if you buy your parents’ house and rent it back to them, you’ll probably be in a position to profit from the tax benefits of owning investment property. Meanwhile, your parents stay in their familiar house, with cash in their pockets.
In most cases, your parents won’t owe any tax on the sale. As long as they’ve lived in the house at least two years, they can avoid tax on $500,000 worth of gain ($250,00 for single taxpayers). With tax-free cash from the sale, your parents will likely to be able to pay a “fair market rent” to keep living in the house. That’s a requirement in order for you to maximize your tax advantages.
In any case, you’ll be allowed deductions for property taxes and mortgage interest, the same as if you used the property as a vacation home. However, if the rent is fair and the house is considered rental property, you also can take deductions for operating expenses such as utilities, maintenance, insurance, repairs, supplies, and so on.
Travel expenses also may be deductible: if you go to visit your parents, some or all of your expenses can be written off as investment property monitoring. In addition, residential properties placed in service can be depreciated over 27.5 years.
These deductions can offset the rental income you receive from your parents so most or all of this income can be tax-sheltered. If your expenses exceed the rental income, the loss may be deductible, in whole or in part, if your income is under $150,000.
**Editor’s Note:
For more information on how you can take advantage of your home’s equity, see item #8 below or go to https://www.fedweek.com/Publications/default.asp.**
