I want to retire to the San Diego coast. My son wants to invest in real estate. Should I rent a home from him, and rent our $2.5M San Francisco pad to our son?
My husband and I are both retired. My husband pulls in Social Security at 64 while I wait to move mine in at 70 (which will be in another four years).
We have been fortunate to have owned a home in one of the hippest markets in the San Francisco Bay Area since 1999. It would be worth at least $ 2.5 million if we sold it now. Our mortgage payment is $ 1,800 per month, and we are overpaying $ 300 to the financier every month.
We want to enjoy retirement on the San Diego coast without having to sell our home. My son is in his late twenties, earns a six-figure salary, and has considerable savings. He wants to invest in real estate to reduce his tax burden.
I suggested that he buy a house or condo somewhere on the San Diego coast that he would rent to us. Then he and a couple of his friends can rent our house in the Bay Area where they all work. We estimate we charge $ 4,000 to $ 4,500 a month in rent, which can add extra income to my husband and I while we enjoy our retirement. Is that a good suggestion? Are there any drawbacks we should be aware of? I appreciate your advice.
Sincere,
Retirement on the coast
‘The Big Move’ is a MarketWatch column that covers the ins and outs of real estate, from finding a new home to applying for a mortgage.
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Dear pensioner,
On the surface, you have a win-win situation. You and your husband want to retire to a cozy beach house and your son wants to invest in real estate. It’s easy to see why you wouldn’t want to try hitting two boardwalks with one stone.
However, the strategy you have come up with is actually more complicated than you might think, for a number of financial and emotional reasons.
Let’s start with the latter: renting out to a family is not for the faint of heart under the simplest of circumstances. The arrangement you envision is far from easy. You wouldn’t just rent to your son and friends. He rents to you too. That naturally complicates things.
Think of the myriad of headaches a landlord faces: maintenance issues, late rental controls, complaints from neighbors, whatever. That’s enough fodder for conflict before the typical family quarrel is thrown into the mix.
I don’t know what the relationship between you and your husband is like with your son. If the three of you normally enjoy open, reasonable, and calm communication, you may not face an overly turbulent situation. If you often disagree and give each other every throat then why should you do business together?
Even if your relationship is solid, you must at least sign contracts with each other and agree on the terms and conditions. You don’t want to wait for a problem to arise to decide how to deal with it.
“If the IRS determines that a home is being used for personal purposes, then restrictions on rental allowance may apply.”
As for the financial considerations, you need to be extremely careful when renting to family members so as not to incite the ire of the IRS. Chances are, both you and your son want to be able to deduct relevant expenses for each of your homes – such as mortgage interest, insurance, maintenance, and depreciation. This helps reduce taxable rental income.
There is a catch, however: according to the IRS, a secondary home could qualify as personal residence if it is used by “a family member or family of someone else who is interested, unless that family member uses it” as their primary residence and pays a fair rental price. “
If the IRS determines that a home is being used for personal purposes, restrictions on deductible expenses may apply. So if you’re not careful, you can essentially suffer one two-two tax blows, from renting a home to being a family member.
For this reason, you should be careful when giving rental discounts to your son (and vice versa). Appraiser. Keep this in case the IRS requires evidence.
According to the American Institute of Certified Tax Planners, “a taxpayer may be able to give his relative a small discount by taking advantage of what is known as a ‘good tenant discount’.” In the past, this discount could be as high as 20%. but the organization says that if you only give a 10% discount, you will be safer these days.
And don’t think that you can replenish things any further by giving cash gifts to each other to offset the rent. When faced with an audit, these gifts could haunt you.
Finally, since you are a California resident, there are property tax considerations. As I recently explained to a letter writer, recent proposals have made it difficult to pass inheritance tax breaks down from generation to generation when converting the house in question into a rental apartment.
So before proceeding with your plan, be sure to consult a real estate attorney who is knowledgeable about these property tax matters to determine how this approach could affect the taxes your son may face if he later inherits your ex-home.
Ultimately, the scheme you are considering has many potential problems. That doesn’t mean you shouldn’t continue, but it does highlight the need to proceed with caution and seek ongoing advice from tax and legal professionals. Either way, I hope that you and your husband will manage to find the way you want to retire and enjoy this next chapter in your life with your toes in the sand. Much luck!
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