When our parents age, oftentimes their home has appreciated in value but they are no longer enjoying the benefit of homeownership tax breaks after they retire. What should you do to leverage this situation for the mutual benefit of both you and your parents? Easy, buy their home and rent it back to them for a win-win situation.
Since your parent’s home may be paid off (or mostly paid off) and because your parents are likely in a lower tax bracket due to their retirement, any deductions that might be possible if they are still carrying a mortgage do not provide much tax savings for them. Even with that being the case, why should your parents entertain selling their home to you? First, it gives them immediate access to cash vs. taking out a home equity line of credit. Second, it allows them to invest the sale proceeds in a more stable investment vehicle than real estate.
Now in order to avoid any IRS pushback, you must pay fair market value for their home which should be supported by a qualified, independent appraisal. Otherwise, the purchase is considered a “part sale” and “part gift” by the IRS. Once the purchase is complete, you and your parents will then enter into a lease for the home’s market rental value. Please be aware that if the rent is too low, the IRS could allege the home is for personal use and would then limit your deductions as if this home was merely a vacation home (i.e. deductions only for mortgage interest and property taxes).
However, if you follow the steps outlined above, you will then be able to enjoy all of the tax benefits of owning rental property i.e. write-offs for operating expenses for the property including maintenance, insurance, repairs, utilities and supplies. Furthermore, you can also claim depreciation deductions for the home itself (but not for the land since the land is nondepreciable). These deductions will help offset the rental income you receive from your parents and you will also be able to take any suspended losses once you sell the home. Finally, you may even be able to write off the occasional travel expense you pay when visiting your rental investment i.e. your parent’s home.
Ultimately, your parents will not live in the home forever. Once this occurs, you can sell the property, rent it to another tenant or even move into the home. If you make this home your primary residence for at least two years, you can sell it and shelter another $250,000 to $500,000 worth of capital gains-one last tax win!
If you would like to help your parents gain access to cash and save money on your taxes, contact our office to discuss how we can help you purchase your parent’s home to help you take advantage of this win-win plan.