Renting below fair market value to a family member does not stop you from being a landlord in the eyes of the IRS, but it does change what you can deduct. Under Internal Revenue Code Section 280A, every day a relative occupies the property at a discount counts as a day of personal use by you. That reclassifies the dwelling as a personal residence and caps your deductions at the rent you actually collect, so the property cannot produce a tax loss. The discount itself is treated as a gift, though the 2026 annual exclusion of $19,000 per recipient means most family landlords will never file a gift tax return over it.
Why a Discount Turns the Property Into a Residence
The tax code treats a property as your personal residence if you or a related party use it for personal purposes more than the greater of 14 days or 10% of the days it was rented at a fair price. The trap for family landlords is in the definition of personal use. Under Section 280A, any day a family member occupies the unit counts as your personal use day unless they pay a rent that qualifies as fair. Rent below fair market value does not qualify.
The math is unforgiving. A full-year rental to your son at a $400-per-month discount produces 365 personal use days for you, and the property is automatically a residence. The same result applies if you charge no rent at all. Once that classification triggers, you cannot claim a net loss on the property no matter how much you spent on mortgage interest, repairs, or insurance.
How the Deduction Cap Works
When Section 280A applies, you first allocate every shared expense between rental use and personal use based on the ratio of rental days to total days of use. The rental portion is then deducted in a strict order, and only to the extent your rental income can absorb each layer.
- Mortgage interest and property taxes allocable to the rental period come off the top of your rental income.
- Operating costs such as utilities, insurance, and repairs are deducted only from whatever rental income is left after the first layer.
- Depreciation comes last, limited to whatever income remains after the first two.
If interest and taxes alone equal or exceed the rent you collected, you get zero deduction for operating expenses and depreciation on the rental portion for that year. Disallowed amounts from the second and third layers carry forward to future years, but they remain subject to the same income cap when you get there. The property cannot shelter other income on your return.
The $25,000 Passive Loss Allowance Will Not Rescue You
Landlords who actively participate in a rental can normally deduct up to $25,000 in passive rental losses against other income, with the allowance phasing out once modified adjusted gross income exceeds $100,000. It is natural to assume this cushion applies here. It does not.
The Section 280A income cap runs before the passive activity rules do. Because 280A already prevents any net loss from existing, there is no passive loss for the $25,000 allowance to absorb. The allowance only helps when the property is otherwise eligible to produce a deductible loss, and a below-market family rental is not.
Charging Fair Market Rent Instead
The clean way to preserve full deduction rights is to charge your family member actual fair market rent. IRS guidance is explicit: a family member’s occupancy does not count as personal use if they use the dwelling as their main home and pay a fair rental price. Meet that condition and the property is treated like any other rental, with all ordinary and necessary expenses deductible, potentially including a loss.
This is where families face an honest choice. If the point of the arrangement is helping a relative with housing, charging full market rent defeats it. If the point is building equity in a rental property that happens to have a trusted tenant, charging fair rent protects your tax position entirely.
Establishing Fair Market Value
Whatever rent you decide on, you need a defensible number for FMV. Fair market value is what an unrelated, willing tenant would pay for the property in its current condition.
Pulling comparable rental listings in the same neighborhood is the most straightforward method. Look for properties similar in size, bedroom count, condition, and amenities. Three to five solid comparables give you a reasonable basis. Online rent estimates from Zillow and Redfin can supplement the research; the IRS itself uses these platforms as starting points when evaluating property values, though internal guidance cautions against relying on any single automated estimate.
A written appraisal from a licensed real estate appraiser gives you the strongest defense if the IRS challenges the number. It typically costs a few hundred dollars. For most single-family rentals, printed comparable listings plus screenshots of online estimates will do, but an appraisal is worth the expense if the property is unusual or the rent discount is large. Whatever method you use, document it and keep the file with your tax records.
Gift Tax on the Rent Discount
The gap between fair market rent and the rent you actually charge is a gift for federal tax purposes. If fair rent is $2,000 a month and you charge your daughter $1,200, you are making a $9,600 gift to her over the year.
For 2026, the annual gift tax exclusion is $19,000 per recipient. As long as the annual discount stays below that threshold, you have no filing obligation and no gift tax consequence. A married couple can elect to split gifts, effectively doubling the exclusion to $38,000 per recipient. Most residential discounts sit comfortably under these limits.
If the discount exceeds $19,000 in a year, you must file Form 709 to report the gift. Filing does not mean you owe tax. The excess reduces your lifetime unified credit, which stands at $15 million per individual for 2026. Almost no family landlord will exhaust that exemption through rent discounts.
What the Tenant Owes
Nothing, in most cases. Gifts are excluded from the recipient’s gross income under federal tax law, and the rent discount is a gift from you to them. Your family member does not report the discount as earnings or miscellaneous income. The full tax cost of the arrangement lands on you through the lost deductions.
Reporting and Records
You report the rental on Schedule E (Form 1040), Supplemental Income and Loss, even when the tenant is a family member paying a discounted rent. Schedule E asks for gross rents received and itemizes deductible expenses by category: taxes, interest, repairs, insurance, depreciation, and other costs.
Beyond the return, keep a file that includes your FMV analysis (comparable listings, online estimates, or an appraisal), a signed lease with the family member, records of every rent payment received, and receipts for expenses you deduct. The lease does not have to be elaborate, but a signed document stating the monthly rent, the term, and the tenant’s responsibilities strengthens the argument that a genuine landlord-tenant relationship exists.
Keep records of how you allocated expenses between rental and personal use. If the IRS questions the arrangement, the allocation methodology matters as much as the dollar amounts, and a contemporaneous record made when you filed is far more persuasive than one reconstructed during an audit.