Question: Are there any restrictions on renting a house to a relative? I want to buy my mother's home, then rent it back to her. This would provide her with a monthly income (from the mortgage payments), free her from house worries and provide me with a tax shelter. Can I do this without creating problems with the IRS?
Answer: Right now this is a gray area. The Internal Revenue Service believes that present tax law imposes limits on the deduction allowable to owners of property rented to family members.
In the IRS view, such owners may deduct only those amounts authorized for one's own home: property taxes, mortgage interest and casualty losses.
Not authorized for property rented to relatives, the IRS believes, are deductions for such things as repairs, insurance and depreciation -- the kinds of deductions that normally are valid for rental property.
Exception: These deductions would be allowed up to the net amount of rental income left after deducting the total of the three authorized categories above.
Last fall the IRS announced its intention to issue tax rulings with these tough restrictions, based on their strict interpretation of a 1976 law that many feel was intended to apply only to vacation homes.
But Congress directed the IRS to hold up on any new regulations for a while to give the lawmakers an opportunity to restudy the law and possibly take action to clarify their intent.
My opinion: The full range of deductions should be permitted when the rental agreement qualifies as an "arm's-length transaction." That is, the terms of the rental -- in particular, the amount of rent paid -- should be the same as would be offered to a stranger.
But the question is still up in the air while Congress and the IRS take a good look at the situation. So I suggest you tread carefully, maybe hold up for a while until the question is settled.
Q: I would greatly appreciate it if you would clarify the tax status of dividends from money market funds for 1981. I am getting conflicting opinions as to whether the dividends qualify for the $200 exclusion.
A: Probably you're getting conflicting opinions because the rules are different for 1981 than they were for 1980.
Money market fund payouts are categorized as dividends when paid to the individual investor. But since the original source of the income to the fund was interest, these dividends didn't qualify for the $100 dividend exclusion in 1980.
For 1981 and 1982, however, the exclusion is increased from $100 to $200 per taxpayer. And it applies to interest as well as dividends, with no requirements to prorate the $200 between the two.
So far this year and next, dividends from money market funds will qualify for the exclusion. (And on a joint return the exclusion is $400 regardless of which spouse owns the shares.)
Q: In your tax articles you advise people to use the peel-off address labels on their returns. Doesn't this label contain added information that may make me more susceptible to an audit?
A: Let me quote from a January 1981 letter from James F. Boyle, IRS district director in Richmond, to tax practitioners in which he urged use of these labels:
"Contrary to the myth which circulates in some quarters, neither the label itself nor the coding on it are audit indicators in any way."
The main item on that label is the taxpayer's name and address. In addition, there are some mysterious notations on the top line, and maybe I can make them less mysterious.
The first item -- the two-letter entry on the left -- is computer shorthand for your name. This is followed by your Social Security number (both numbers on a joint return). With the two letters and SSN, the IRS can identify the correct account.
The next item -- a letter and a two-digit number -- represents the IRS district where you filed the previous year's return. The number that follows that indicates the type of tax package mailed to you (determined by the return you filed last year).
You may also find a line of printing at the very top of the label. This is not tax-related information, but rather IRS notations for the Postal Service. "CAR-RT SORT," for instance, simply means that the IRS bulk mailing has been sorted by carrier route, which gets the IRS a lower postal rate (available to private mailers also).