ALBUQUERQUE, N.M. — Q: In an earlier column you explained that the new tax law limit on deductions for taxes, which is $10,000 per year, does not apply to property held for investment. The prior question was about undeveloped land held for investment and you said that the property taxes would be deductible without regard to the $10,000 limit. I am concerned about my situation which seems to have better facts. I bought a house that I am renting to my daughter. She is paying me $800 per month rent which I admit is less than the fair value, but it is all that she can afford. I am aware that the tax law says that if I rent to my daughter for less than fair rent then I am considered to have used the house for personal purposes. But my question is whether this means that the property taxes will be subject to the $10,000 limit? Between state income taxes and property taxes on my own home I am already over that limit. It seems from your earlier answer that if the house was vacant and held for investment then I could deduct the taxes? It would seem crazy if renting to my daughter for $800 per month would make the taxes nondeductible.
A: Interesting twist on the facts of the prior column. I think the answer is the crazy one — the property taxes will be subject to the $10,000 limit. This is so even if you bought the property for investment purposes.
To explain this I need to proceed step-by-step through the law. First, beginning in 2018 taxes are limited to an aggregate of $10,000 per year. The law says that this limit excludes taxes on property held for investment or business use.
That was the basis for my earlier answer. Let’s continue assuming that you bought this house as an investment, with your daughter occupying it as her residence at a below-market rent.
Rental property usually results in reporting of rent income and allowed expenses, which include utilities, maintenance, interest, and property taxes. Section 280A may limit the ability to claim some of those expenses if the property is used for both personal and investment use.
Section 280A is often called the “vacation home” rules although it is much broader than that. It limits deductions for either investment or business expenses associated with a property used as a “residence.”
This provision does not limit deductions that would be allowed even if the property was used for purposes other than investment or business. The problem is that property taxes may now be limited if they related to use other than business or investment.
So this means that the 2017 law changes can limit property taxes for personal-use property and Section 280A can limit those expenses for business or investment use property. But the latter limitation applies only for use as a “residence.”
That’s where your issue arises. Renting for fair rental value is not use by you as a residence. Personal use by a family member is the same as personal use by you — unless the family member pays fair rent.
Section 280A often applies to “mixed” use property – used for rental and for personal use. That is why some people call these rules the “vacation home” rules. But if your daughter is the only occupant of the property, and she pays less than fair rent, then the statute says you have 100% residence use.
This means 100% disallowance of the deductions per the rules of Section 280A. Again, these rules do not apply to deductions that are allowed apart from the property being used for investment or business.
But the new tax law then subjects these otherwise allowed expenses to the general limits for personal-use property. You can still deduct the mortgage interest. But the property taxes now becomes part of the overall $10,000 limitation.
If you left the property vacant and your intent was to hold for investment purposes (which may itself be challenged), there would be no limit on the property taxes. This may seem crazy but a vacant house is not being used by a family member as a residence and therefore does not trigger Section 280A limitations.
James R. Hamill is the Director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at firstname.lastname@example.org.