Tuesday, September 11, 2018

Rental property also used for personal use

Vacation home rentals and the TCJA

The law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, may have unforeseen indirect consequences for taxpayers with dwellings used for both short-term rental and personal purposes, often referred to as mixed-use vacation homes. The TCJA's increase in the standard deduction and limitations on itemized deductions for state and local taxes (SALT) and home mortgage interest may affect the vacation home rental expense allocation under Sec. 280A(c)(5)(B) between personal and rental use, particularly for a dwelling that is unused for significant periods.


There have been many disputes over the proper allocation under Sec. 280A of certain expenses between personal and rental use. This issue came to a head in Bolton, 77 T.C. 104 (1981), aff'd, 694 F.2d 556 (9th Cir. 1982). The IRS argued (and proposed in Prop. Regs. Sec. 1.280A-3(c)) that the rental portion of real estate taxes and mortgage interest should be allocated by the ratio of total rental days to the total number of days the property was used for any purpose during the year. This has become known as the "IRS method." However, the taxpayers in Bolton argued, and the Tax Court and Ninth Circuit agreed, that these expenses should be allocated by the ratio of total rental days to the total number of days in the year (subsequently referred to as the "court method" or "Bolton method"). The Tax Court also applied the court method in McKinney, T.C. Memo. 1981-337, aff'd, 732 F.2d 414 (10th Cir. 1983). As a result, taxpayers (particularly those in the Ninth and Tenth circuits) have support for using either method (see the table "IRS and Court Methods" for a comparison). (Note that IRS Publication 527, Residential Rental Property (Including Rental of Vacation Homes), lists only the IRS method, reflecting the IRS's continuing position that it is the only permissible method.)
A taxpayer's decision to allocate expenses by the IRS or court method may be affected by the TCJA's increase in the standard deduction or limits on SALT and mortgage interest deductions.
Thanks to Connor Gibson, CPA for information contained in this article.