Federal Tax Question - Is it A Rental Property???

I inheritied my fathers residence in 2005 when he passed away. One of his requests was that his then girlfriend be allowed to remain in the residence rent free. The attorney that handled the estate setup an agreement that she would be able to remain in the house rent free for 5 years, she signed a lease, etc. The lease reflects $0 annual rental payments. My question is can I still treat this property as a rental and take advantage of all of the tax benefits that accrue? I know there has to be an effort made to rent and there are issues if the rent charged is below the average rent for your area. Worst case I guess would be I can only deduct property taxes paid but not homeowners insurance, depreciation, etc... Next question - I have recently paid said individual a sum of money and in return she has terminated the lease agreement and has moved out of the residence. Can I deduct the early lease termination payment I made to her from my income? Any help greatly appreciated, thanks!

Public Comments

1. My first suggestion is to hire a professional. This is a complex area and you have unusual transactions. Generally speaking, rental activities of this sort are treated as a passive activity, so any losses incurred can only be deducted against other passive sources of income. There is an exception if you "actively participate" in the rental property (i.e., manage it). In this case it may be possible to deduct up to $25,000 of losses against other (active) types of income. This amount is fazed out at a 50% rate as your AGI exceeds $100,000, so you get nothing if your AGI exceeds $150,000. You might also not be able to deduct losses because they arise from transactions with potentially related parties (as defined in the tax code). Overall, I would suggest that you seek professional advice on this one.
2. i believe if the home is listed as a rental and it was left for her to live rent free( which that's what it reads like to me) YES...all the perks, i would also right off your fee for early termination or vacancy..but to be more accurateley you can contact your local attorney in your area...
3. This sounds to me like this is a rental not for profit. You can deduct your expenses up to the amount of income you received (Which was $0.00) You can deduct the property taxes paid on Schedule A. Any expenses to maintain or improve the home would be added to the basis of the home and depreciated when you start renting the home for profit.
4. I would treat the house as a second home. Mortgage interest and taxes would be a deduction on schedule A. Now that it is truly a rental, you can treat it as such in the future.