The Pros and Cons of Renting to Family
Rental income is not created equal. Rent payments coming from friends and family come with unique complexities. There are several factors that investors need to take into consideration when renting to friends and family members. First of all, investors need to know the finer points of the ‘personal use’ tax trap.
If an investor moves family members into their property, such as a vacation rental, or, allows a child to stay in a property near the child’s college, or even moves their parents into a newly rehabbed rental property – the IRS deems these situations ‘personal use’ *unless the investor can prove that the property is a rental.
Personal use is handled like a second dwelling. The property owner loses the ability to deduct typical rental deductions.
A dwelling unit could be a house, apartment, condominium, mobile home, boat, or vacation home. It does not include property used solely as a hotel, motel, inn, etc.
Here is what investors absolutely need to know about the personal use tax trap. The IRS uses a ‘14 days per year’ rule to determine if a property is a personal use dwelling (exempt from rental reductions) or a rental dwelling (subject to rental reductions). If the property owner used the property for more than 14 days in a year, then it is personal-use property. The other way a property can qualify for rental deductions is for the property to be used less than 10% of the total days it is rented at a fair price.
The admonishment here is family member use days count as personal use days. This is because a family member is counted as an extension of the property owner. If the family member pays a fair rental price, this can be avoided. However, if the rent is not a fair market rental price, this could create personal use time.
Overall, there are pros and cons to renting to friends and family members.
Can’t beat the friends/family screening process – there is pre-existing knowledge!
Even with the best screening practices, less than desirable tenants can end up in rental properties. These types of tenants can create headaches and financial loss in the form of increased wear and tear on the property.
Helping someone in need is rewarding
The feeling of helping a friend or family member, and the goodwill that is created, is hard to put a price on.
No false information in the screening process
One way less than desirable tenants are able to pass screening processes is to lie during the application process. With friends and family members, there is a relational track record can replace the application process, which creates more faith.
Hard to ask for rent increases/expectation of preferential treatment
By definition, investors are looking to increase the return of their investment. When friends and family members are the tenants creating the rental income, awkward tension can exist making it difficult to ask for the market rent when the market justifies an increase in the rent.
Potential to upset/ruin relationships
When a relationship such as a friendship or family member is subjected to the hierarchy of a landlord-tenant dynamic, the result can be a loss of amiability.
Potential to have space boundaries crossed
Moving friends and family members into investment properties are inviting them to a new level of trust as well as closeness. This opens pandora’s box to personal space boundaries being pushed and pulled. It is highly recommended that healthy boundaries are stated expressly as well as written into the contract. Remember, a contract is only in place to aid when things go wrong – investors will be happy to have a contract if situations do deteriorate.
They may feel awkward about bringing up necessary maintenance/repairs
Friends and family members, generally speaking, want to see their loved ones do well. They do not wish to be the ones to bring up bad news. If necessary repairs and maintenance appear to them as bad news, they will not be prompt to mention the worsening conditions to the investor. Once again, it is important to talk about circumstances such as this and create boundaries before the friend or family members begin the lease or moves in.