2002 U.S. Master Tax Guide pages 299 & 300
966. Deductions on Rental Residence or Vacation Home. Special rules limit the amount of deductions that may be taken by an
individual or an S corporation in connection with the rental of a residence or vacation home, or a portion thereof, that is also used as the taxpayer's residence (Code Sec. 280A).172
Minimum Rental Use. If the property is rented for less than 15 days during the year, no deductions attributable to such rental are allowable and no rental income is includible in gross income. Deductions allowed without regard to whether or not the home is used for business or the production of income (e.g., mortgage interest, property taxes, or a casualty loss) may still be deducted.
Minimum Personal Use. If the home is not used by the taxpayer for personal purposes for the greater of (a) more than 14 days during the tax year or (b) more than 10% of the number of days during the year for which the home is rented at a fair market rental, the limitations in Code Sec. 280A do not apply. However, the deductibility of expenses still may be subject to the hobby loss rules of Code Sec. 183 if the rental of the residence is not engaged in for profit. See ¶ 1195.
Deduction Limitations. If the property is rented for 15 or more days during the tax year and it is used by the taxpayer for personal purposes for the greater of (a) more than 14 days or (b) more than 10% of the number of days during the year for which the home is rented, the rental deductions are limited. Under this limitation the amount of the rental activity deductions may not exceed the amount by which the gross income derived from such activity exceeds the deductions otherwise allowable for the property, such as interest and taxes. According to the IRS expenses attributable to the use of the rental unit are limited in the same manner as that prescribed under the hobby loss rules at ¶ 1195 (i.e., the total deductions may not exceed the gross rental income and the expenses are further limited to a percentage that represents the total days rented divided by the total days used). However, the Tax Court has rejected this formula (the decision has been affirmed on appeal by both the Ninth and Tenth Circuit Courts of Appeals).173 It is the Tax Court's position that mortgage interest and real estate taxes are not subject to the same percentage limitations as are other expenses because they are assessed on an annual basis without regard to the number of days that the property is used. As a result, the formula employed by the Tax Court computes the percentage limitation for interest and taxes by dividing the total days rented by the total days in the year. The following example illustrates the operation of the two methods for allocating rental unit expenses.
Example. During the year an individual rents out his vacation home for 91 days and uses the home for personal purposes for 30 days. The gross rental income from the unit is $2,700 for the year. He pays $621 of real property taxes and $2,854 of mortgage interest on the property for the year. The additional expenses for maintenance, repair and utilities total $2,693.
The IRS allocation of all expenses would be based on 75% (91 days rented ÷ 121 days used). In contrast, the Tax Court would allocate taxes and interest based on 25% (91 days rented ÷ 365 days) and use the 75% limitation for the additional expenses for maintenance, repair, etc.
IRS Tax Court
1. Gross rental income $ 2,700 $ 2,700
2. Less. Interest ($2.854) 2,141 - 714
Property tax ($621) - 466 - 155
3. Remaining available income $ 93 $ 1,831
4. Utilities, rnaintenance, etc - 93 - 1,831
5. Net income 0 0
6. Unused expense allowable as itemized deductions:
Interest $ 713 $ 2,140
Property tax 155 466
7. Total allowable deductions $ 3,568 $ 1,306
A vacation home is deemed to have been used by the taxpayer for personal purposes if for any part of the day the home is used (Code Sec. 280A(d)(2)):
Footnote references are to paragraphs of the 2002 Standard Federal Tax Reports.
173 ¶ 14,854.30,