[{"@context":"https:\/\/schema.org\/","@type":"Article","@id":"https:\/\/moneydoneright.com\/taxes\/personal-taxes\/below-market-rent\/#Article","mainEntityOfPage":"https:\/\/moneydoneright.com\/taxes\/personal-taxes\/below-market-rent\/","headline":"Below Market Rent: Tax Consequences of Renting Below Fair Market Value","name":"Below Market Rent: Tax Consequences of Renting Below Fair Market Value","description":"Most people who invest in rental property do so with a profit motive, oftentimes...","datePublished":"2020-03-04","dateModified":"2022-06-28","author":{"@type":"Person","@id":"https:\/\/moneydoneright.com\/author\/logan-allec\/#Person","name":"Logan Allec, CPA","url":"https:\/\/moneydoneright.com\/author\/logan-allec\/","identifier":4,"image":{"@type":"ImageObject","@id":"https:\/\/secure.gravatar.com\/avatar\/6e74dd0453a5871d1dcfde6d40d9494765ca8bfdb01927cefee4564d4bee9075?s=96&d=mm&r=g","url":"https:\/\/secure.gravatar.com\/avatar\/6e74dd0453a5871d1dcfde6d40d9494765ca8bfdb01927cefee4564d4bee9075?s=96&d=mm&r=g","height":96,"width":96}},"publisher":{"@type":"Organization","name":"Money Done Right","logo":{"@type":"ImageObject","@id":"https:\/\/moneydoneright.com\/wp-content\/uploads\/Money-Done-Right-Personal-Finance-and-Investing-Blog.png","url":"https:\/\/moneydoneright.com\/wp-content\/uploads\/Money-Done-Right-Personal-Finance-and-Investing-Blog.png","width":488,"height":60}},"image":{"@type":"ImageObject","@id":"https:\/\/moneydoneright.com\/wp-content\/uploads\/2019\/05\/Below-Market-Rent.jpg","url":"https:\/\/moneydoneright.com\/wp-content\/uploads\/2019\/05\/Below-Market-Rent.jpg","height":430,"width":825},"url":"https:\/\/moneydoneright.com\/taxes\/personal-taxes\/below-market-rent\/","commentCount":"6","comment":[{"@type":"Comment","@id":"https:\/\/moneydoneright.com\/taxes\/personal-taxes\/below-market-rent\/#Comment1","dateCreated":"2023-10-08 05:34:55","description":"So question for you on this. My condo mortgage is $1140 a month HOA $965. Electric is $115 that only utilities everything else is inlude in HOA dues. Cable is $85. My brother pays $400 a month rent, but he pays electric and cable bills as well. He does and groceries shopping does 60% cleaning and cooking. Per hud fair market for Minneapolis area is $1074. Can I use this for tax deduction?","author":{"@type":"Person","name":"Peter Jorgenson","url":""}},{"@type":"Comment","@id":"https:\/\/moneydoneright.com\/taxes\/personal-taxes\/below-market-rent\/#Comment2","dateCreated":"2023-04-03 06:05:20","description":"Not sure but this seems to suggest deductions outside of schedule A would be allowed. https:\/\/www.irs.gov\/faqs\/sale-or-trade-of-business-depreciation-rentals\/personal-use-of-business-property-condo-timeshare-etc\/personal-use-of-business-property-condo-timeshare-etc-1","author":{"@type":"Person","name":"Eric","url":""}},{"@type":"Comment","@id":"https:\/\/moneydoneright.com\/taxes\/personal-taxes\/below-market-rent\/#Comment3","dateCreated":"2021-10-13 13:33:47","description":"Hi Brian. In this case, if you're renting it out to someone else for four years, it wouldn't be your primary residence for two out of the last five years, so you wouldn't qualify for the Section 121 exclusion<\/strong><\/a>.","author":{"@type":"Person","name":"Logan Allec, CPA","url":""}},{"@type":"Comment","@id":"https:\/\/moneydoneright.com\/taxes\/personal-taxes\/below-market-rent\/#Comment4","dateCreated":"2021-09-21 14:10:46","description":"Great summary. Easy to understand explanation. Question, if you do rent the residence out at below market for say 4 years, can you then sell it and still be eligible for the $500K (MFJ) capital gains exclusion on a primary residence. Or are you still subject to the 2 out of 5 year rule?","author":{"@type":"Person","name":"Brian","url":""}},{"@type":"Comment","@id":"https:\/\/moneydoneright.com\/taxes\/personal-taxes\/below-market-rent\/#Comment5","dateCreated":"2019-05-20 12:50:17","description":"Hi Stanley. Those are great questions.\n\nAs you know, in the situation you described, you would be renting your townhome at below market rent. \n\nYou would have to report your rents collected for the year on on Schedule 1, Line 21, where it will flow to page 2 of your 1040 and be taxed at your ordinary income tax rates.\n\nIn terms of deductions, you would not be able to deduct your HOA dues, but you may be able to deduct your mortgage interest (which is only a portion of your monthly payment) and property taxes on Schedule A insofar as these amounts are not limited, respectively, by the $1,000,000 \/ $750,000 mortgage interest limitation and \/ or the $10,000 limitation on the deduction for state, local, and property taxes.\n\nSo yes, it appears that you will have to pay taxes on the $1300 that you're charging as rent when in fact, you're not profiting (or you're at least not cash flow positive).\n\nHowever, as noted in the article, there may be some strategies you can apply to your specific situation that can give you a better tax answer with your below market rental. Since these strategies may or may not be applicable to your situation, it is recommended that you reach out to a qualified tax professional to discuss your options.\n\nYou can certainly convert your townhome to a market value rental property whenever you like. When this happens, you will report your rental income and expenses on Schedule E. However, you will not be able to recoup the deductions you previously incurred when the property was a below market rental.","author":{"@type":"Person","name":"Logan Allec","url":"https:\/\/moneydoneright.com"}},{"@type":"Comment","@id":"https:\/\/moneydoneright.com\/taxes\/personal-taxes\/below-market-rent\/#Comment6","dateCreated":"2019-05-19 16:54:05","description":"Thanks for your article. It was exactly my question, and the answer seems clear. However, sometimes we want to be able to serve people in our church family that doesn't make financial sense. Perhaps you can shed a bit more light on a specific situation. My cost to own my townhome is a mortgage of about $1300 and HOA about $400. The market value is about $2000, which our neighbor pays for the comparable unit. However, we'd like to rent it out to a church family for $1300. The question is, how would taxes work, since I'm actually taking a loss? Will I have to pay taxes on the $1300 that I'm renting out for when in fact, I'd would NOT be profiting? \n\nFrom another standpoint, can I rent it out as a below market value for 2 years and then after they move out, to bring it back to at market value rental property?","author":{"@type":"Person","name":"Stanley","url":""}}],"about":["Personal Taxes"],"wordCount":1979,"keywords":["schema"],"articleBody":"Most people who invest in rental property do so with a profit motive, oftentimes raising the rents as high as they can in order to maximize their income.Table of ContentsToggleRenting Below Fair Market ValueReporting Fair Market Rentals on TaxesWhere Fair Market Rentals Are ReportedWhat Fair Market Rentals May DeductHow Fair Market Rental Losses Are TreatedAre Fair Market Rentals Eligible for 1031 Exchange Treatment?Reporting Below Market Rentals on TaxesWhere Below Market Rentals Are ReportedWhat Below Market Rentals May DeductHow Below Market Rental Losses Are TreatedBelow Market Rentals: Other Tax ConsequencesTax Strategies for Below Market RentalsJust How Bad Are Below Market Rentals?Strategy 1: Have Your Tenant Improve the Property in Exchange for Reduced RentStrategy 2: Charge Fair Market Rent and Gift the DifferenceStrategy 3: Don’t Exceed a 20% DiscountAvoid Below Market Rents if PossibleRenting Below Fair Market ValueBut in other situations, maximizing profits may not be the ultimate motive.\u00a0 In these situations, a landlord may be willing to rent to a tenant at below fair market value.This is quite common in rental arrangements between family members, such as a wealthy parent purchasing a property near their child’s university and renting below market value to them, or perhaps an adult child letting his or her aging parents live in a property they own and only covering the mortgage or utilities.Sometimes, a landlord may even rent at below market value to a friend or even a friend of a friend.Regardless of what the arrangement is, the IRS has very specific tax rules when it comes to renting to someone below fair market value.Before we discuss what these rules are, let’s discuss how rental income is generally reported on the landlord’s income tax return.Want to talk to a tax pro about your real estate investments?\u00a0 Email me at realestate@loganallec.com!Reporting Fair Market Rentals on TaxesThe tax code is quite generous to landlords who rent out their property at fair market rent.Such landlords may take and may even incur a rental loss that they may roll forward to future tax years or, in certain tax situations, deduct against their other forms of income.This favorable tax treatment for such landlords results from the fact that they are viewed by the IRS as engaging in their rental activity for profit, and the IRS generally allows those who engage in some profit activity to deduct their ordinary and necessary expenses against such profit activity.Where Fair Market Rentals Are ReportedIn general, rental income is reported on a landlord’s Schedule E, Part I: Income or Loss from Rental Real Estate and Royalties.The amount derived at the bottom of this form is then input on Schedule 1, Line 17, where it is combined with other tax items on Line 22.\u00a0 This Schedule 1, Line 22 amount is then input on Form 1040, Page 2, Line 6, next to where the form reads, “Add any amount from Schedule 1, Line 22.”What Fair Market Rentals May DeductAs can be seen on Lines 5 – 19 of Schedule E, many deductions are available to landlords.Although a tax professional can best guide you on your specific situation, landlords may generally deduct any cash expenses they incur in generating their rental income, in addition to any depreciation and amortization related to their property.\u00a0 Remember, one cash outlay that is not deductible is mortgage principal payments since that is merely the repayment of a loan, not an expense.How Fair Market Rental Losses Are TreatedWhat if a landlord collects $20,000 of rent during the year and incurs $30,000 of deductions on his or her rental property, thus incurring a $10,000 loss?The tax treatment of this loss depends on if the taxpayer is a real estate professional, and if he or she is not, his or her income level.\u00a0 See the table below..simple_table-30859 table tr th{\ttext-align: center;\t\t}.simple_table-30859 table tr td{\ttext-align: center;\t\t}Real Estate ProfessionalAdjusted Gross IncomeTreatment of Rental LossYesAnyDeduct entire loss against other forms of income.NoLess than or equal to $100,000Deduct up to $25,000 of rental losses against ordinary income and roll the remainder to next year under the passive activity loss rules.NoGreater than $100,000 and less than $150,000\tMaximum rental loss is $25,000 - 50% x (your income less $100,000). Roll remainder into next year under the passive activity loss rules.NoGreater than or equal to $150,000Roll entire rental loss to next yea under the passive activity loss rules.Are Fair Market Rentals Eligible for 1031 Exchange Treatment?When it comes to fair market rentals, the tax benefits don’t stop at being able to take tax deductions.Your rental property is also eligible for a tax-free 1031 exchange, through which you can sell your rental property and not pay any taxes on it (this year, at least) as long as you invest the proceeds in another income-producing property and meet other 1031 requirements.Reporting Below Market Rentals on TaxesNow, what are the tax consequences to you if you rent out your property below market value?You may think that the IRS would reward your generosity, but unfortunately this is not the case.In fact, the IRS simply treats this house as a personal residence.\u00a0 Here’s the kicker from \u00a7280A(d)(2)(C) of the tax code:The taxpayer shall be deemed to have used a dwelling unit for personal purposes for a day if, for any such part of such day, the unit is used…by any individual (other than an employee…), unless for such day the dwelling unit is rented for a rental which, under the facts and circumstances, is fair rental.So what are the tax implications of renting out what amounts to be a personal residence at below market rent?\u00a0 Read on.Where Below Market Rentals Are ReportedIn general, the rents received on a below market rent are reported on Schedule 1, Line 8z “Other Income”, where it is combined with other tax items on Line 10.\u00a0 This Schedule 1, Line 10 amount is then input on Form 1040, Line 8, next to where the form reads, “Other income from Schedule 1, line 10.”What Below Market Rentals May DeductMortgage interest and property taxes are reported on Schedule A, subject to all applicable limitations.\u00a0 This can be a particularly bad tax answer if, say, the taxpayer already pays in excess of $10,000 in state income taxes and\/or property taxes on his or her primary residence, thus eliminating any deduction for property taxes paid on the below-market rental.What about other deductions related to the property such as utilities, homeowners association dues, supplies, etc.?\u00a0 Formerly, these deductions were permitted as a miscellaneous itemized deductions subject to 2% of adjusted gross income insofar as they did not generate a rental loss.\u00a0 However, the Tax Cuts & Jobs Act eliminated this particular category of itemized deductions, so taxpayers may no longer take a deduction for these expenses on properties they rent below market value.How Below Market Rental Losses Are TreatedNo losses are permitted on below market rentals in the current year, and they are not carried forward to future years.Below Market Rentals: Other Tax ConsequencesAnother tax consequence of below market rentals is that because the property is not used in a for-profit activity, it is not eligible for a 1031 like-kind exchange.However, if it was used as the taxpayer’s primary residence for at least two of the five years preceding the date of sale, it could qualify for the primary residence exclusion under Section 121.Tax Strategies for Below Market RentalsIf you’ve followed this article up to this point, it’s probably pretty clear to you that below market rentals aren’t exactly the cat’s pajamas when it comes to your tax return, and you could very well end up paying more in taxes charging lower rent!Just How Bad Are Below Market Rentals?To recap just how bad below market rentals can be for your tax return, consider the summary chart below.\u00a0 While you will certainly be taxed on the below market rents you collect, your ability to take deductions against your rental income is drastically reduced when compared to a fair market rental..simple_table-30861 table tr th{\ttext-align: center;\t\t}.simple_table-30861 table tr td{\ttext-align: center;\t\t}Fair Market RentalBelow Market RentalRental IncomeReported on Schedule EReported on Schedule 1Mortgage InterestDeducted on Schedule EDeducted on Schedule A, subject to limitationsProperty TaxesDeducted on Schedule EDeducted on Schedule A, subject to limitationsOther Rental ExpensesDeducted on Schedule ENondeductibleEligible for 1031 ExchangeEligibleIneligibleBelow, I’ve provided you with a couple ideas that may allow you to treat your rental property as a fair market rental, thereby giving you Schedule E tax treatment and entitling you to all the rental deductions described under “Reporting Fair Market Rentals on Taxes” above.So what can be done?\u00a0 You want to help your friend or family member out by not charging them fair market rents, but you also don’t want to be stuck with a bad tax situation.Make note that this is not tax advice, and you should certainly discuss any strategies mentioned below or on this site with a qualified tax professional before implementing them.Strategy 1: Have Your Tenant Improve the Property in Exchange for Reduced RentOne thing you can do is have your tenant pay you a reduced cash amount in rent every month and make up the difference with services performed such as keeping up the property or improving the property in some way.Note that this is considered an “in-kind” rent payment, so you and your tenant must agree on what the value of these services are \u2014 and they must be reasonable, or else the IRS could disregard them \u2014 and you must report these in-kind rent payments as rental income on your tax return in addition to the cash rents received.Strategy 2: Charge Fair Market Rent and Gift the DifferenceAnother strategy is to collect fair market rent from your tenant and gift them the difference between the fair market rents and the desired rent.\u00a0 Please note that this strategy may be challenged by the IRS as a sham, so be sure to discuss with a qualified tax professional before pursuing it.Remember, however, that the 2022 annual gift exclusion amount is $16,000, meaning that if any one person gifts any other one person in excess of $16,000, the one giving the gift must file a Form 709 Gift Tax Return.Note, though, that the annual gift exclusion is on a per-person basis.\u00a0 So if you’re married, you and your spouse could each separately gift $16,000 each to one individual and not have to file a gift tax return.\u00a0 And if that individual is married, you and your spouse could each separately gift $16,000 each to that individual’s spouse.\u00a0 What if that individual has children?\u00a0 The same applies.\u00a0 So theoretically, a married couple could transfer up to $96,000 of wealth to a family of three without having to file a gift tax return (see chart below)..simple_table-30862 table tr th{\ttext-align: center;\t\t}.simple_table-30862 table tr td{\ttext-align: center;\t\t}Spouse A GivesSpouse B GivesTotalReceived by Spouse C$16,000$16,000$32,000Received by Spouse D$16,000$16,000$32,000Received by Child$16,000$16,000$32,000Total$48,000$48,000$96,000Strategy 3: Don’t Exceed a 20% DiscountAlthough this is not in the tax code, there have been some IRS rulings in which reasonable “good tenant” discounts of 10% – 20% off fair market rent have been permitted on a Schedule E rental activity.Of course, these rulings were based on some other taxpayer’s very specific facts and circumstances and may or may not apply to your facts and circumstances.To be safe, I recommend consulting with a tax professional to discuss your tax minimization options.Avoid Below Market Rents if PossibleAt the end of the day, you want to help someone else pay less in rent, but you should also look to your own tax situation.In fact, the less you pay in taxes to Uncle Sam, the more opportunity you have to help others in your community.So if you’re considering a below-market rent situation, be sure to consult with a qualified tax professional as well as perhaps a real estate attorney if you’re going to be getting fancy with your lease 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