Purchasing a house, regardless of whether your intention is to use it as a personal residence or rent it to your parents, doesn’t present you with any opportunities to claim tax deductions. However, when you start collecting rental income from your parents, there is a wide range of tax deductions you can claim to reduce your taxable rental income.
Purchase of Home
At the time you purchase the house, the Internal Revenue Service requires you to capitalize all costs you incur to acquire it. In addition to the purchase price, you must also capitalize your closing costs, such as attorney fees, title insurance and transfer taxes. The total of all costs you capitalize is equal to your tax basis in the property. Tax basis is significant because it represents the amount you can receive tax-free when you sell the house. Your taxable gain, however, is equal to the sales proceeds minus your tax basis. The tax basis in the house is also significant for purposes of claiming the annual depreciation deductions you are eligible to take once you start renting the home to your parents.
Rental Home Depreciation
A deduction for depreciation is only available beginning with the month your parents move into the house and start paying rent. This is because you can never depreciate your personal homes, and until you begin renting it, the IRS treats the home as a personal residence. Depreciation deductions are a way to recover a small percentage of your tax basis each year with a tax deduction. However, the IRS requires you to allocate your depreciation over 27.5 years, yielding annual depreciation deductions equal to approximately 3.6 percent of your tax basis in the house. There is no requirement that you claim depreciation, but if you do, keep in mind that it will decrease your tax basis each year. Reducing your tax basis will increase the amount of taxable gain you must recognize if and when you sell the house.
Provided your parents pay a market rate of rent each month, your relationship with them doesn’t affect your ability to claim deductions for your rental expenses. However, you can deduct your rental expenses only if you report all rental income on your tax return every year. Deductible rental expenses include the cost of utilities if your parents aren’t responsible for their payment, the cost of repairs you make to the home, charges for landscaping during the summer as well as the annual property taxes and mortgage interest you pay during the year.
Claiming Rental Expenses
The IRS requires that you separately report the rental income you receive from your parents and the deductions that relate to the rental on a Schedule E attachment to your personal return. The Schedule E allows you to separately calculate your taxable rental income, which is equal to the annual rent income minus your expenses. Once you complete Schedule E and calculate your net rental income, you transfer the amount to the gross income section of your 1040 form on the appropriate line for rental real estate.
- IRS: Publication 551 - Basis of Assets
- IRS: Publication 527 - Residential Rental Property
- Internal Revenue Service. "Tips on Rental Real Estate Income, Deductions and Recordkeeping." Accessed Sept. 30, 2019.
- Internal Revenue Service. "Publication 946, How to Depreciate Property." Accessed Sept. 30, 2019.
- Internal Revenue Service. "Publication 551, Basis of Assets." Accessed March 16, 2020.
- Internal Revenue Service. "Publication 527, Residential Rental Property." Accessed March 16, 2020.
Jeff Franco's professional writing career began in 2010. With expertise in federal taxation, law and accounting, he has published articles in various online publications. Franco holds a Master of Business Administration in accounting and a Master of Science in taxation from Fordham University. He also holds a Juris Doctor from Brooklyn Law School.