Can I Rent My House Out to My Spouse?

It is legally permissible to rent a home you own to your spouse. This arrangement, however, is a financial transaction subject to strict oversight by the Internal Revenue Service (IRS). The tax implications require careful adherence to a specific set of rules. To treat the property as a rental for tax purposes, the arrangement must be handled with the same formality as a transaction between unrelated parties. This involves establishing a formal lease, documenting payments, and correctly reporting income and expenses. Failing to follow these regulations can lead to the loss of deductions and tax complications.

The Fair Market Value Rent Requirement

The foundation of a valid rental arrangement with a spouse or any relative is charging Fair Market Value (FMV) rent. FMV is the price a property would command on the open market. The IRS mandates this to prevent taxpayers from creating artificial rental losses to offset other income. If you charge your spouse rent that is below FMV, the IRS will not consider it a legitimate rental.

Determining the correct FMV requires documentation. You can research comparable rental listings in your neighborhood on platforms like Zillow or local classifieds, looking for properties of similar size, condition, and with similar amenities. For a more formal valuation, you might consult a local real estate agent who can provide a rental analysis. The most defensible method is to obtain a formal rental appraisal from a licensed appraiser. Maintaining records of your research is important to substantiate the rental rate if the IRS questions the arrangement.

Allowable Expense Deductions

When you charge fair market value rent, you can treat the property as a business asset and deduct the associated costs against the rental income. These deductions reduce the taxable profit from the rental activity. The expenses must be ordinary and necessary for managing and maintaining the rental property. It is important to categorize these expenses correctly to ensure compliance.

Deductible expenses include:

• The portion of your mortgage interest and property taxes that corresponds to the rental use of the property. If the entire home is rented, 100% of these costs for the rental period are deductible as rental expenses and are claimed directly against the rental income.
• Operating expenses such as premiums for landlord or hazard insurance, any homeowners’ association (HOA) fees, and utilities like water or gas if the lease agreement stipulates the landlord is responsible for them.
• The cost of repairs made to keep the property in good working condition, which can be deducted in the year they are paid. This includes fixing a leaky faucet or repairing a broken window. These are distinct from capital improvements, which are investments that add value or extend the property’s life.
• Depreciation, a deduction that allows you to recover the cost of the building itself over time. For residential rental properties, the IRS allows you to depreciate the cost basis of the building (but not the land) over 27.5 years. This non-cash expense can provide a substantial tax benefit.

Tax Reporting and Personal Use Limitations

Properly reporting your rental activities is a requirement for maintaining its tax status. The rental income received from your spouse and all allowable expenses are reported on Schedule E (Form 1040), Supplemental Income and Loss. This form organizes your rental finances and calculates the net profit or loss, which then flows to your main Form 1040 tax return.

The tax benefits of a rental property are contingent on limiting your personal use of the dwelling. A property is considered a personal residence if you use it for personal purposes for more than the greater of 14 days or 10% of the total days it is rented at fair market value. When renting to a spouse, special rules can classify days as personal use.

Renting at a rate below FMV automatically makes all rental days personal use days. Furthermore, for the property to be treated as a rental, it must be used as your spouse’s principal home. If they use it as a second or vacation home, those days also count as your personal use, which can push you over the limit.

If the property is reclassified due to excessive personal use, the tax consequences are direct. You can still deduct rental expenses, but only up to the amount of rental income you receive. This means you cannot claim a net rental loss to reduce your other taxable income. Any expenses that exceed the rental income in that year are generally not deductible.

Impact of Joint Property Ownership

The dynamic of renting to a spouse changes if both spouses own the property jointly. When both names are on the deed, a traditional landlord-tenant relationship is not recognized for tax purposes. One co-owner cannot legally pay “rent” to the other for the right to use a property they already have a legal ownership interest in.

In this scenario, any payments made between the spouses are viewed by the IRS as a form of cost-sharing or reimbursement for household expenses, not as taxable rental income. Consequently, the homeowner cannot file a Schedule E to report rental activity. Instead, shared home expenses are treated as they would be for any personal residence. Allowable deductions like mortgage interest and property taxes would be claimed as personal itemized deductions on Schedule A.