'I will soon turn 65': My son wants to live in my investment property for less than market rent. Do I say yes?

By Quentin Fottrell 'I would like to quit working' "What will become our primary residence in Tennessee has a $350,000 mortgage at almost 6%." (Photo subjects are models.) Dear Quentin, I will soon turn 65 and I would like to quit working. My wife and I purchased a home in Tennessee a few years ago to be closer to her father. We have our house in Southern California with a $350,000 mortgage at 3%. It's worth about $1.2 million. Our mortgage and impound account is about $2,450 a month on this property. What will become our primary residence in Tennessee has a $350,000 mortgage at almost 6%. Our mortgage and impound are just under $2,500 a month. Our son would like to stay there and start a family. We have agreed to let him rent this for $3,200 a month. Homes in the area rent between $4,000 and $4,500. The home was a rental from 2008 to 2022, but I have resided there for the past three years, anticipating the move out of state. What would be the pros and cons of having this as a "second home" and letting the son rent it? Another sticky part is renting a home below its value. It's been suggested that if the low rent is truly an issue, could we "gift" him the difference? The home is in a trust that would eventually go to him and his adult brother. How do I ensure an equal inheritance for both? Frequent Reader You can email The Moneyist with any financial and ethical questions at qfottrell@marketwatch.com, and follow Quentin Fottrell on X, the platform formerly known as Twitter. Don't miss: 'I enjoy vacations to Europe': I'm 75 and have $1 million in an IRA. Why do I feel guilty? By subletting to your son at a lower-than-market rent, you may be restricting your ability to reap tax benefits from this rental property. Dear Frequent, Here are five reasons why you should think carefully: This commitment to your son could make it tough for you to use this home and visit your wife's family. By subletting to him at a lower-than-market rent, you may be limiting some tax deductions. You would create an expectation that, despite putting your properties in a trust so they can be divided equally among your sons, this son will inherit this property. You could adversely impact your capital-gains tax exclusion. And finally, your retirement should be the top priority. Under Internal Revenue Service rules, it's perfectly fine to rent to a family member at below market rent - but doing so has significant tax implications, not least by limiting and/or preventing myriad expense-related deductions. The IRS classifies such an arrangement as personal use of the property, which is a "not-for-profit" service. If you charge fair-market value (FMV), you can deduct eligible expenses like mortgage interest, property taxes and maintenance costs. "However, if the rent is below market value or treated as personal-use property, you may lose these deductions or have them limited," according to Advantage Property Management, based in Collierville, Tenn. "Detailed records are essential to substantiate eligible expenses. A formal rental agreement helps establish a legitimate landlord-tenant relationship. It serves as documentation for IRS purposes, showing the arrangement is business-like." There are pros and cons of renting to a family member. "You ensure the property remains in trustworthy hands and maintain regular communication with tenants you know well," it adds. "This can simplify the leasing process and reduce the risk of property misuse. However, challenges may arise when maintaining a professional arrangement. Additionally, disputes may occur if expectations around payment, maintenance, or property use aren't formally established." There are other tax issues. You could, as you suggest, charge fair-market value and gift your son the difference. This may be the best outcome, given that the annual gift excursion is $19,000 a year as an individual and $38,000 as a married couple. If the fair market value less the actual rent exceeds the annual exclusion, the excess could require filing a gift-tax return Form 709, even if no tax is due. Additionally, if you have lived in the Tennessee home for three out of the last five years, you may qualify for the $500,000 married-filing-jointly capital-gains exclusion; renting could close that window. The IRS may allow for a partial exclusion if you sell for valid reasons after meeting the two-year use (but less than five years). It's relatively easy to equalize the inheritance for your sons, even if you make gifts during your lifetime. You can adjust the distribution in your will or trust, reducing your son and daughter's shares by the amount you have gifted each. A "hotchpot clause" in your will ensures fairness by effectively deducting the advanced gifts from their inheritance share, retroactively calculating what each heir has already received and helping to ensure that everyone gets an equal amount. "It also has a basis in the doctrine of satisfaction - the assumption that a parent would not want to benefit one child twice at the expense of the others," according to the Society of Will Writers. "A hotchpot clause is not asking for the gift to be repaid to the testator's estate. It is merely recognizing its existence so that the beneficiary's share in the estate can be reduced and the end result is that all children have received the same benefit overall." Another, hopefully easier, pitfall to avoid: It's hard to live in a home for any length of time without growing emotionally attached to it. Be transparent about your long-term plans for both properties, so your two sons are kept up to speed. If that means the California and Tennessee properties will be put in a trust and divided equally among your sons, so be it. I assume the California property is worth far more than the one in Tennessee. For that reason, you should have no arguments. Related: My husband, 73, is giving me a life estate in his home, yet leaving his son a $200K Porsche. Is this cause for divorce? The Moneyist regrets he cannot reply to questions individually. More columns from Quentin Fottrell: My therapist said he was in-network. He's not. Am I obliged to pay out-of-network rates for all prior sessions? Can my husband contest his late brother's $600K will? He experienced oxygen deprivation due to COPD before he died. I have early Alzheimer's and my husband has stage 4 kidney disease. We just inherited $50K. How can this help us? Check out the Moneyist private Facebook group, where we look for answers to life's thorniest money issues. Post your questions or weigh in on the latest Moneyist columns. By submitting your story to Dow Jones & Co., the publisher of MarketWatch, you understand and agree that we may use your story, or versions of it, in all media and platforms. -Quentin Fottrell This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal. (END) Dow Jones Newswires 01-15-26 1837ET