Tax treatment when co-signing for a loan and also renting rooms?

Question

My daughter is starting a 5 year graduate school program for which she will be paid a decent amount as a graduate research assistant.  I am considering helping her buy a house (we will both be on the loan and title) in which she will live and also rent out 1 or 2 rooms.

From what I've been able to find, I understand that if I make a portion of the mortgage payment, I am entitled to a proportional portion of any personal deductions (e.g. the mortgage interest deduction).

I also understand that if a part of a home is used as a personal residence and a part is used as a rental, that the costs are split proportionally in order to determine how much cost is considered personal and how much is considered a cost of the rental.

What I haven't been able to figure out is how to treat the costs and income if we share ownership of the house and we both contribute to the payments while she uses a portion as her personal residence while we also rent out 1 or 2 rooms.

Can anyone help me understand how to allocate the costs and income?  Or where to find information on this?  Thanks.

Ashish Acharya · Answer

I am assuming this is SFH.

This is complicated than you think. With her being on the title makes it worse.  You might want to look into vacation home rules.

Since she is also the owner, her use of the house is considered personals use days.

In your case, If the other rooms are not rented regularly and are used exclusively by the renters, there is a limitation on your expense deduction. This is called a vaction home rule. However, read below:

Portion of a Home Rented to Others

• If your purchase was multi-family( duplex and up), there would be no limitation because Personal use is measured based on each dwelling unit, which includes a house, apartment, condominium, mobile home, boat, or similar property that provides basic living accommodations such as sleeping space, toilet, and cooking facilities. A single structure may contain more than one dwelling unit. For example, each apartment in an apartment building is a separate dwelling unit. Similarly, if the basement of a house contains basic living accommodations (e.g., a cooking area and bathroom), it is a separate dwelling unit [Prop. Reg. 1.280A-1(c)(1)]. Thus, each of the dwelling units in a single home is tested separately to determine if it is a personal residence, vacation home, or rental activity.
• It is not clear how a single dwelling unit that is used both by the owner (or a family member) and by unrelated parties who pay rent is treated. This is a fairly common scenario for parents of college students who find that buying a house or condo near the campus for their child to live in is a better investment than paying rent or dormitory fees. Often, the owner's child shares the home with other students who pay rent to the owner. If all share a single kitchen (or other living accommodations such as a bathroom), there is only one dwelling unit. Clearly, the child's use of the home is counted as personal use by the owner. Thus, it would seem impossible for the homeowner to escape the Section 280A vacation home limitations, since personal use of the dwelling unit will exceed the greater of 14 days or 10% of the days the home is rented.
• Prop. Reg. 1.280A-1(c)(2), which excepts from the definition of dwelling unit any portion of a unit used exclusively as a hotel, motel, inn, or similar establishment, seems to apply to this situation. The regulation specifically states that this exception may apply to a portion of a home used to furnish lodging to tourists or to long-term boarders such as students (if that portion is regularly available for occupancy by paying customers and the owner is not treated as using that portion as a residence during the tax year). Thus, it appears that any portion of a home used exclusively by a paying renter (e.g., a bedroom) is not included in the dwelling unit and accounted for separately as a rental property. In that case, any net loss attributable to that portion of the home would be deductible as a rental (passive) loss, rather than being subject to the vacation home limitations.
• However, before relying on Prop. Reg. 1.280A-1(c)(2), practitioners should consider Morcos, where the court ruled that the taxpayer could not use the proposed regulation to treat the third floor of his home (which was rented on a long-term basis) as not part of his dwelling unit. Instead, the third floor was considered part of a single dwelling unit (the rest of which was occupied by the taxpayer and his family) so that any losses attributable to the rented portion of the home were subject to the vacation home limitation. The court found that the rental of the third floor was not a business, but rather an arrangement to offset the homeowner's personal living expenses. Such would generally be the case when parents purchase a home near a college campus for their children and rent a portion of that home to third parties.

Eamonn McElroy · Answer

@Scott Cole

@Ashish Acharya provided a nice summary.  A person is able to deduct personal mortgage interest for their principal residence as well as one second home.  This was what your original question referred to and what my answer responded to.  If your daughter is not your dependent, then the home in question must be used by you (or a member of your household) as a residence for the greater of 14 days or 10% of the number of days the house is rented at FMV for you to qualify the house in question as a second home and deduct your share of the "personal" mortgage interest on your Schedule A.

You most likely do not meet the threshold to call this house a second home but might be able to through planning.

The other question, the question that you did not ask in your OP, is about the mortgage interest allocated to the rented bedrooms.  Yes, this will most likely be deductible for you on Schedule E of your return.

Agree that this situation is complicated.  Specifically because you're buying the home with your daughter and she's not your dependent.  It furthers complicates because there's personal use on her part and presumably not yours.  Thus there could be a situation where she's subject to IRC Sec 280A and you're not.  Then there's the gift tax potential depending on how the loan payments are getting made and what the agreement is regarding sales proceeds if the house is ever sold.

Good for a deep dive with your CPA.  Might just be cleaner to co-sign on the loan, have her make all the payments, and have just her on the title.  Food for thought.

Scott C. · Answer

@Eamonn McElroy Thanks for the follow-up response.  The information is very helpful.  I figured it must be fairly common for a parent to buy college housing with both the parent and the child on the deed and the loan and with the intent to rent out a room to someone else.  I clearly saw what I wanted to see when I did my initial research and didn't dig deep enough.

Scott C. · Answer

@Ashish Acharya thanks for the reply.

My daughter and I plan to buy the SFH together as her income as a graduate student will be nice, but not enough to qualify for the house.  The plan is to rent out 2 of the extra bedrooms.  The baths, kitchen, and living areas will be shared.

The information you provided is very helpful.  I am a CPA, but I deal with GAAP and treasury work rather than individual taxes.  You are right in that this is more complicated than my original research revealed.

Scott C. · Answer

@Eamonn McElroy thanks for the reply.  I do see that if a parent co-signs on a student loan, the child has to be a dependent of the parent in order for the parent to  be able to deduct the interest.

You are correct in that my daughter will not qualify as a dependent.  But I have found numerous sources that say that if a person has a legal obligation to pay a mortgage loan, that person is able to deduct any mortgage interest that the person actually pays.  If that person is also on the title, he/she is also able to deduct any property taxes paid.  Both of these assume that the person meets the other requirements for deducting mortgage interest and property taxes.  Am I missing something?  Thanks again for the reply.

Eamonn McElroy · Answer

"From what I've been able to find, I understand that if I make a portion of the mortgage payment, I am entitled to a proportional portion of any personal deductions (e.g. the mortgage interest deduction)."

Maybe, maybe not.

Depends on if your daughter is your dependent or not for tax purposes.  If she's getting paid a "decent amount" as a graduate research assistant and providing more than half of her own support, she's probably not a dependent.

Tax treatment when co-signing for a loan and also renting rooms?

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