Can I rent my replacement property to my child, my parents or my own business?

A fair rental plus the tenant's principal residence is what converts family occupancy into investment use

Start with the trap. Section 280A(d)(2)(A) deems you to have used a dwelling unit for personal purposes on any day it is used by a member of your family as defined in section 267(c)(4), and it attaches no fair-rent proviso to that clause. On its face, letting your daughter live in the house makes every one of those days your own.

Section 280A(d)(3)(A) is the release valve and it is written in one sentence: a taxpayer "shall not be treated as using a dwelling unit for personal purposes by reason of a rental arrangement for any period if for such period such dwelling unit is rented, at a fair rental, to any person for use as such person's principal residence."

Two conditions, both required. The rent has to be a fair rental, and the house has to be the tenant's principal residence rather than their weekend place. Discount the rent or let them keep another main home and you are back inside 280A(d)(2)(A).

The dwelling-unit safe harbor imports the same two subsections, which is why the relief carries into your exchange

Section 4.03 of Rev. Proc. 2008-16 says personal use occurs on any day you are deemed to have used the unit for personal purposes "under §280A(d)(2) (taking into account §280A(d)(3) but not §280A(d)(4))." The parenthetical is the whole answer: a properly priced family tenancy does not consume your personal-use allowance.

Section 4.02(2) then asks, for each of the two 12-month periods after the exchange, that you rent the unit at a fair rental for 14 days or more and keep personal use to the greater of 14 days or 10 percent of the fair-rental days. A house your father occupies as his home for a full year is rented 365 days, so the allowance is 36 days, and none of his occupancy counts against it.

How long you must rent a replacement before moving in covers the two-year mechanics of that safe harbor; this page is only about who the tenant may be.

What a fair rental means when the tenant is your son, and how the Tax Court looked at it

Section 4.04 of the revenue procedure sets the standard: whether a unit is rented at a fair rental is judged on all the facts and circumstances existing when the rental agreement is entered into, taking all rights and obligations of the parties into account. It is the bargain you struck at signing, not a rent survey pulled three years later.

That flexibility is real but narrow. Legal 1031 reports that in William P. Adams v. Commissioner, T.C. Memo. 2013-7, the IRS attacked a $1,200 monthly rent charged to the taxpayer's son on a dilapidated house, and the taxpayer prevailed by showing the rent was fair once the son's uncompensated work and out-of-pocket improvements were weighed.

Build the record before the first rent cheque rather than after an examination letter.

• A written lease with a term, a rent figure, a due date and a late-payment clause you are willing to enforce.
• Evidence of the market rent you relied on when you signed: comparable listings, a broker's letter or a property manager's opinion.
• Rent actually paid from the tenant's own funds and deposited, not offset informally against something else.
• The rent reported on Schedule E with depreciation and expenses claimed, which is how the return says you held the property for income.
• No arrangement to hand the rent back as a gift, which unwinds the fair-rental premise the whole position stands on.

A relative who owns a slice of the house needs a shared equity financing agreement

Section 280A(d)(3)(B)(i) withdraws the principal-residence relief where the occupant holds an interest in the unit, unless the rental is made under a shared equity financing agreement. Families who put a child on title to help with financing walk into this without noticing.

The definition is demanding. Section 280A(d)(3)(C) requires two or more people to acquire qualified ownership interests, with the occupant entitled to live there as a principal residence and obliged to pay rent to the other owners; section 280A(d)(3)(D) defines a qualified ownership interest as an undivided interest of more than 50 years in the entire dwelling unit and its land.

Where such an agreement exists, 280A(d)(3)(B)(ii) fixes the fair rental as of the time the agreement is entered into and adjusts it for the occupant's own ownership share. Adding a relative to title also raises a same-taxpayer question on the exchange itself; see adding or removing a spouse on title.

Leasing to a company you control is a different question with a simpler answer

Section 280A governs dwelling units, so a warehouse, clinic or retail bay leased to your own operating company is not touched by the personal-use rules at all. Section 1031 asks only that you hold the building for productive use in a trade or business or for investment, and a building leased at market rent to any tenant, including your own company, is held for exactly that.

The catch is elsewhere. Treas. Reg. §1.469-2(f)(6) recharacterizes rental income as nonpassive to the extent of net rental income from property rented for use in a trade or business activity in which you materially participate, so your self-rental profit cannot soak up passive losses from other rentals.

That matters if you were counting on suspended losses to shelter the rent; using suspended passive losses in a 1031 exchange works through the interaction.

Section 1031(f) asks who you exchanged with, not who signs the lease

Section 1031(f)(1) fires only where the property you hand over in the exchange goes to a related person. Leasing the replacement to a relative afterwards is not an exchange and does not start that clock; see the two-year rule for related-party exchanges.

What a family tenancy does risk is the holding requirement itself, which is a question of intent and documentation rather than of statutory timing. Rent below market is the single fact most likely to persuade an examiner that you bought a home for a relative rather than an investment.

These rules interact with gift tax and with your own state's landlord-tenant law, so confirm the lease and the rent with your CPA or attorney before the exchange closes.