The IRS has specific rules for renting property to family members and friends, which can affect your taxes. Ultimately, understanding these rules and strategies can help you maximize your deductions and reduce your taxable rental income.

Ordinarily, you’re entitled to deduct the expenses of owning and operating a rental property. You may even be able to claim a loss if those expenses exceed your rental income (subject to certain limitations). 

However, if you rent a property to a family member or friend for less than fair market rent, the IRS will consider the property to be a personal residence rather than a rental property. As such, you’ll still have to report the rental income on your tax return, but you’ll lose many of the deductions associated with rental properties. (Although depending on your circumstances, you may still be able to deduct some or all of your mortgage interest and property taxes.)

Personal Property or Rental Property?

The IRS generally considers a property to be a personal residence if it is rented to a family member or friend at less than fair market rent. In other words, the rental income must be commensurate with what you would receive from someone unrelated to you. If you’re charging your tenant substantially less than market rent, then the IRS may consider the property a personal residence. In this case, your deductions will be limited to mortgage interest and property taxes, depending on your circumstances.

The type of lease agreement you have with your tenant can also affect how the IRS treats the rental income. If you have a long-term lease agreement or an option to purchase agreement in place, then the IRS may consider the property a rental property even if you’re charging below market rent. In these cases, you will generally be entitled to the same deductions as any other landlord.

Finally, it's important to keep good records of all rental income and expenses related to your rental properties. This includes tracking payments from tenants, receipts for repairs or improvements made to the property, and any other expenses related to rental properties. Keeping accurate records can help you maximize your deductions and minimize your taxable rental income.

In conclusion, understanding the IRS’s rules for renting to family members or friends is essential for any landlord looking to minimize their taxable rental income. Knowing when a property is considered a personal residence or a rental property, and which expenses can be deducted regardless of the tenant’s identity, can help you maximize your deductions and reduce your tax burden. Keeping accurate records of all rental income and related expenses is also important in helping to ensure that you pay the least amount of taxes possible. And of course, it's important to talk with your advisor to strategize for your situation.