Quick overview

Renting to a relative is common, but the IRS treats these arrangements like any other rental when money changes hands — with a few special rules. You must report rental income, may be able to deduct expenses and depreciation, and should document market-rate terms to avoid gift-tax or personal-use reclassification issues. For detailed rules on reporting and allowable deductions see IRS Publication 527: Residential Rental Property and Topic 414: Rental Income (IRS.gov).

How federal tax rules apply

  • Reporting rental income: Landlords report rent received on Schedule E (Form 1040) unless the activity qualifies as a business rental (rare for family situations). Include all amounts received for rent, advance payments, and nonrefundable fees. For guidance see IRS Topic 414 and Publication 527 (https://www.irs.gov/publications/p527).

  • Deductions and expense allocation: If you rent part of a dwelling you occupy, you must reasonably allocate expenses between the rental portion and the personal portion. Typical allocable expenses include mortgage interest, property taxes, insurance, utilities, repairs, and depreciation (use Form 4562 for depreciation). Recordkeeping is essential. See Publication 527 for allocation examples.

  • Below-market rent and personal use rules: If you charge substantially less than fair market value to a related person, the IRS may view the unit as used for personal purposes rather than as a rental activity. That can limit deductible losses — you cannot claim rental losses that are primarily personal. Publication 527 explains when rental activity is considered personal use.

  • Gift tax considerations: Charging rent far below market value can be treated as making a gift of the difference. Gift tax rules and annual exclusions apply; check current IRS guidance before assuming there’s no gift implication (https://www.irs.gov/businesses/small-businesses-self-employed/gift-tax).

  • Security deposits and advance rent: A refundable security deposit generally isn’t income when received; it becomes income only if you keep it. Nonrefundable fees and advance rent are taxable in the year received; Publication 527 and IRS Topic 414 provide details.

Practical examples (typical scenarios)

Example 1 — Renting a basement apartment to an adult child for market rent

  • You charge a fair market rent, have a written lease, and tenants pay utilities separately. Report all rent on Schedule E, allocate a percentage of mortgage interest, property tax, insurance, repairs and depreciation to the rented area. Losses and deductions are treated like any other rental.

Example 2 — Renting a room for well below market to help a family member

  • If rent is significantly below market and you continue to use the home personally, the IRS may treat the arrangement as personal use. You may still report the rent as income but deductible expenses generally cannot create deductible rental losses. Also consider gift tax rules if the rent difference is large and recurring.

Example 3 — Short-term, occasional help with no formal lease

  • Informal arrangements increase audit risk and reduce your ability to substantiate deductions. Without a written lease and clear payments, the IRS may disallow rental losses and reclassify transactions.

How to calculate the rental portion for deductions

  1. Measure the area: Use square footage (rentued area ÷ total home square footage). For rooms with similar finish and use, this is standard.
  2. Allocate direct expenses entirely to the rental unit (repairs inside the rented area).
  3. Allocate indirect expenses (mortgage interest, property taxes, insurance, utilities) using the square-footage ratio or rooms ratio.
  4. Depreciate the rental portion of the property on a 27.5-year recovery period for residential rental property; use Form 4562.

Example calculation (simple): If basement is 20% of house square footage, you can generally allocate 20% of mortgage interest, taxes, insurance, utilities and depreciation to rental activity.

Recordkeeping checklist (why this matters)

  • Written lease signed by both parties showing rent, term, and responsibilities.
  • Bank records showing rent paid (avoid cash if possible).
  • Itemized receipts and invoices for repairs, maintenance, utilities, and improvements.
  • Mileage log for trips related to rental activity.
  • Photographs or floor plans showing the rented area (helpful if allocation is questioned).

For more on staying organized see our guide: Recordkeeping Best Practices for Small-Scale Rental Income.

Situations that commonly cause trouble

  • No written lease or irregular payments. This makes it hard to prove bona fide rental activity and can trigger disallowance of losses.
  • Charging well below-market rent without documenting family need or business reasons. May be treated as personal use or gift.
  • Trying to deduct large improvements as repairs. Capital improvements must be depreciated and recaptured on sale.
  • Failing to report nonrefundable fees, advance rents, or amounts you retain from security deposits.

Interplay with other tax areas

  • Basis and capital gains: Renting part of a home and claiming depreciation lowers your adjusted basis for that portion; if you later convert or sell the property, depreciation recapture may apply and reduce the Section 121 exclusion for owners who used the home as a primary residence (see our related article: Tax Implications of Selling Rental Property).

  • Passive activity rules: Rental activities are generally passive; passive loss limitations can prevent you from offsetting rental losses against active income unless you meet exceptions (publication on passive activity rules). If you materially participate, different rules may apply.

  • Insurance and liability: Renting to family doesn’t eliminate landlord liability — maintain landlord insurance and consider an LLC or umbrella policy for serious liability protection; see: Using LLCs and Insurance to Shield Rental Properties.

Best-practice checklist before you sign a lease with family

  • Use a written lease with clear rent, term, security deposit, utilities and maintenance responsibilities.
  • Charge a market or near-market rent where feasible; document how you determined fair market value.
  • Keep all rent payments traceable (checks, bank transfers).
  • Separate personal and rental expenses in your bookkeeping.
  • Discuss whether the arrangement could be considered a gift and consult a tax advisor about gift-tax reporting if rent is below market.

FAQs

Q: Do I always have to report rent paid by family?
A: Yes — all rental income must be reported. The nature of deductions depends on whether the unit is considered rental or personal use (see Pub. 527).

Q: Can I deduct all my mortgage interest and property taxes?
A: Only the portion allocable to the rental unit is deductible against rental income. The remainder stays on Schedule A (if you itemize) or subject to current rules for SALT and mortgage interest.

Q: What if family members pay utilities directly?
A: When tenants pay utilities directly, the landlord can’t deduct those amounts; the landlord would deduct only what they actually paid.

Professional tips from practice

  • I recommend a short written lease even for family. In my experience, a lease reduces misunderstandings and creates a paper trail that supports deductions.
  • When you subsidize rent for a family member, document the reason (medical need, temporary job loss) and keep records — it’s useful if the IRS questions whether the arrangement was purely personal.
  • If you expect losses or complex tax consequences (dep. recapture, converting primary residence to rental), consult a CPA before you open the doors.

Authoritative sources and where to read more

Professional disclaimer: This article is educational and does not substitute for personalized tax advice. Tax law changes regularly; consult a qualified tax professional or CPA for guidance specific to your situation.

If you want a practical checklist or a sample rental allocation worksheet adapted to your situation, I can prepare a template you can take to your tax advisor.