Imagine this:  A tax deduction for you, and tax-free income for Mom and Dad

It doesn’t have to be Mom and Dad. This tax-free income can go to your brother or sister, or your even best friend.

To make this work, you need to have a business reason to travel and stay overnight at the Mom and Dad Hotel.

Say you travel to a convention, rent your parents’ guest room for five days, and pay them $1,000 fair rent. You deduct the $1,000 as a business travel expense. Your parents have $1,000 of tax-free income.

Sound good? Great, let’s see how you can make this work for you by following three rules:

Rule 1: 14 Day Limit On Renting

Mom and Dad can rent out a room in their home, or rent their entire house, tax-free if they rent it out for no more than 14 days during the year.

Rule 2: More Than 14-Day Personal Use Requirement

To obtain any tax-free rent, Mom and Dad must personally use the place they are renting to you for more than 14 days during the year.For a primary residence, this isn’t a problem. But for second homes or vacation homes, your rental from Mom and Dad or from your brothers and sisters creates potential trouble. Why? Because the days of your rental (at fair value or not) count as days of personal use for Mom or Dad and for your brothers or sisters.

Rule 3: Fair Market Rental Rate

When you stay at a commercial hotel, you pay an established commercial rate. So when you stay with Mom and Dad, other family, or friends, you also need to pay a commercial rate, which the IRS refers to as a fair market rental rate. Search for rentals in the area, and print a few comparable listings to substantiate the rental rate you are paying Mom and Dad.

Business Lodging Deduction

You must have a receipt or other proof of a lodging expense, regardless of the amount paid. This means, you need to make sure to get a receipt from Mom and Dad and that you pay the amount by check. You need the receipt to prove the lodging and the canceled check to prove that you paid the money. 

Form 1099 

Tax law says that when you pay business rents that exceed $600 to an individual during a tax year, you must report the total of those business rents to the IRS. Hence, if you pay Mom and Dad more than $600 in rent during any calendar year, you have to give them (and the IRS) a Form 1099.

Mom and Dad's Tax Return

As required by IRS regulations, you've completed a Form 1099-MISC that told Mom and Dad and the IRS that you paid them over $600 in rent. Now that you have completed and filed the required 1099, IRS computers are looking for that rent amount on Mom and Dad’s tax return. Also, remember- the IRS does not know that the rent is tax-free until it sees the tax return.

Mom and Dad should report the rental income from the Form 1099 on their Schedule E for the year. Then, because the amount is not taxable, they should subtract that amount in the expense section of Schedule E and add a supporting statement: “Taxpayers rented their personal residence for fewer than 15 days during the taxable year. The rental income was reported on a 1099 and is thus reported as income on Schedule E. That rent is exempt from taxation under IRC Section 280A(g) and is thus removed with the offsetting expense entry on that same Schedule E.”

Sales and/or Occupancy Taxes

All the rules above apply for federal income tax purposes. But there’s a tax collector other than the income tax guy who also has an interest in short-term occupancy. This tax collector specializes in occupancy and sales taxes on hotels, short-term rentals of beach and ski properties, and transient lodging such as that arranged by Airbnb, Homeaway, and VRBO. You might think that the local jurisdiction is unlikely to know Mom and Dad are renting out their home for a few days to a family member. We prefer to think of the occupancy tax this way: paying the occupancy tax adds to proof of the room’s rental.

Because you get the business deduction for your travel, you should have Mom or Dad or other host add the occupancy tax to your lodging bill. Mom and Dad will pay the tax collector but get no deduction for it because the income is tax-free.

Takeaways

Rent for fewer than 15 days. 

Use the property as a home for more than 14 days per year.

Charge fair market price.

If your business travel takes you to an area near your family, rent their guest room and deduct the lodging. Remember the three rules above and not only will you be able to write off the stay, your host will also receive the rent as tax-free income!

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