PORTFOLIO

Home Office, Vacation Home, and Home Rental Deductions (Portfolio 547)

Tax Management Portfolio, Home Office, Vacation Home, and Home Rental Deductions, No. 547-3rd, describes the operation of §280A, which limits deductions attributable to the business and rental use of a dwelling unit if the property is also used by a taxpayer as a residence during the tax year. Section 280A is intended to prevent taxpayers from converting nondeductible personal expenses into deductible business expenses.

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Tax Management Portfolio, Home Office, Vacation Home, and Home Rental Deductions, No. 547-3rd, describes the operation of §280A, which limits deductions attributable to the business and rental use of a dwelling unit if the property is also used by a taxpayer as a residence during the tax year. Section 280A is intended to prevent taxpayers from converting nondeductible personal expenses into deductible business expenses.
The Portfolio analyzes the scope and application of §280A, which applies generally to deductions allowable with respect to a dwelling unit personally used by a taxpayer as a residence. A dwelling unit may be a house, apartment, condominium, mobile home, boat, or similar property with basic living accommodations. Section 280A also applies to other property, such as a garage, which is closely related to the dwelling unit. Section 280A prescribes criteria for determining whether a taxpayer's use of a unit during the tax year is sufficient to trigger the section.
When it applies, §280A generally disallows home business and rental deductions. However, §280A carves out six statutory exceptions to the general disallowance rule. In particular, deductions are not prohibited by §280A for a portion of a dwelling unit used regularly and exclusively: (1) as the taxpayer's principal place of business for any business; (2) as a place where patients, clients, or customers regularly meet or deal with the taxpayer in the normal course of business; or (3) in the case of a separate structure not attached to the residence, “in connection with” the taxpayer's business. Deductions also are not prohibited by §280A for the regular (although not necessarily exclusive) use of a residence for certain storage uses, and for providing day care services. Finally, deductions attributable to the rental use of a residence are not prohibited by §280A.
The standard for determining a “principal place of business” historically caused a significant amount of controversy among taxpayers, the IRS, and courts. This critical standard, one of the lynchpins of §280A, is analyzed in detail in this Portfolio. In Comr. v. Soliman, 113 S. Ct. 701 (1993), the Supreme Court enunciated two primary considerations for determining whether a home office constitutes a taxpayer's principal place of business: (1) the relative importance of the activities performed at each business location, and (2) the relative amount of time spent at each location. A “principal place of business” also includes a place used by a taxpayer to conduct substantial administrative or management activities, if the business has no other fixed location where the taxpayer carries out administrative or management functions.
A taxpayer must allocate home expenses to the portion of the home used for the business activity. A taxpayer who rents a dwelling unit or provides day care services also must allocate expenses based on the amount of time the dwelling unit is used for the activity. A taxpayer may deduct expenses allowable under §280A and allocated to the business or rental use of a home only to the extent of gross income from the business or rental activity. The gross income limitation prevents home business and rental expenses from creating or increasing a net loss from the activity. Section 280A imposes a “tier system” for deducting expenses in cases in which the potential deductions exceed the deductions allowable under the gross income limitation.
Section 280A stakes out the primary ground for determining whether a taxpayer may deduct expenses attributable to a home, including costs for a home office, a vacation home, or a rental home. The rules imposed by the statute are intended to prohibit taxpayers from converting personal expenses into deductible business expenses. Given the often fuzzy line between a valid home business expense and a nondeductible personal expense, it seems likely that the IRS and courts will continue to struggle with issuing rules and decisions that attempt to draw an appropriate line between deductible and nondeductible expenses, and that taxpayers will continue to challenge the rules for allowing deductions in this area.


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AUTHORS

ROBERT W. WOOD
Robert W. Wood is a 1979 graduate of University of Chicago Law School, where he earned a Juris Doctor, won the Florence James Adams Prize and a University of Chicago Scholarship. He practices law with Wood & Porter in San Francisco, California, where he provides services to clients on a wide variety of state, federal, and international tax matters. Mr. Wood is admitted to practice law in California, New York, Arizona, Montana, Wyoming, Washington, Texas, and the District of Columbia. He is also qualified as a Solicitor in England and Wales. Mr. Wood has been designated by the State Bar of California as a Certified Specialist in Taxation. He is a Fellow of the American College of Tax Counsel.
Mr. Wood is the author of more than 35 books in the field of taxation, and has long been recognized as a leading authority and commentator. He is one of the foremost experts on the taxation of damage awards and settlement payments, author of 522 T.M., Tax Aspects of Settlements and Judgments (BNA), and wrote the leading treatise in this area, Taxation of Damage Awards and Settlement Payments (4th ed. Tax Institute © 2009). Mr. Wood frequently serves as an adviser and expert witness on this unique area of the tax law. Mr. Wood is also the author of Qualified Settlement Funds and Section 468B (Tax Institute © 2009), and Legal Guide to Independent Contractor Status (4th ed. Tax Institute © 2007). For a complete list of Mr. Wood's publications, please visit www.woodporter.com.

TABLE OF CONTENTS

Detailed Analysis

I. Introduction

A. Overview

B. Legislative History

C. Structure of Section 280A

II. Section 280A(a) Disallowance of Deductions Attributable to Business Uses of a Home

A. Home Expense Deductions Generally Disallowed

B. Taxpayers Subject to Section 280A

1. Generally

2. Partnerships

3. S Corporations

4. Trusts

C. Property Subject to Section 280A

1. Dwelling Unit

a. Single Structure with Multiple Dwelling Units

b. Appurtenant Property

c. Hotel Exception

(1) Property Regularly Available for Occupancy by Paying Customers

(2) Personal Use Prohibited

(3) Rental Pools

2. Residence

a. General Rule for a Residence

b. Exception for Qualified Rental of Principal Residence

(1) “Principal Residence” Defined

(2) Difference Between “Principal Residence” and “Residence”

(3) Portion of Unit Not Used as Principal Residence

(4) Involuntary Conversion of Principal Residence

c. Separate Structure

D. Personal Use that Subjects a Taxpayer to § 280A Disallowance Rule

1. Use by Taxpayer

2. Personal Use - Attribution Rules

a. Use by Co-Owner

b. Use by Family Members

c. Reciprocal Arrangements - Unit Swapping

d. Bargain Rentals

e. Time Sharing and Rental Pool Use

(1) Time Sharing Arrangements

(2) Rental Pools

(3) Rental Pool Averaging Election

f. Personal Use from Charitable Donation of Use of Dwelling Unit

g. Personal Use by Pass-Through Entity

3. Exceptions to Attribution Rules

a. Rental at Fair Value

b. Shared Equity Financing Agreement

4. Excluded Uses: Holding for Rent, Repair and Maintenance

5. Documenting Personal Use

III. Exceptions to § 280A Disallowance Rule

Introductory Material

A. Exception for Expenses Deductible Regardless of Business Use of Home

B. Exception for Certain Business Use of Home

1. Trade or Business Requirement

a. Multiple Businesses

b. Investment Activity

2. Regular Use

3. Exclusive Use

a. De Minimis Personal Use

b. Dedicated Room

c. Separately Identifiable Space

d. All Uses Must Qualify

4. Qualifying Uses that Must Be Regular and Exclusive

a. Principal Place of Business

(1) Multiple Businesses

(2) Administrative or Managerial Activities as a Principal Place of Business

(3) Principal Versus Secondary Place of Business

(a) Pre-1976 Law

(b) Prior Law: Focal Point Test

(c) Soliman v. Comr.

(i) Lower Court Decisions

(ii) Supreme Court Opinion

(iii) IRS Response to Soliman

(iv) Scope of the Soliman Decision

(v) Post-Soliman Decisions

(d) 1997 Amendment to § 280A - Overruling Soliman on Its Facts

b. Place for Meeting or Dealing with Patients, Clients or Customers

5. Separate Structure Not Attached to Dwelling Unit

6. Qualifying Uses That Must Be Regular, But Need Not Be Exclusive

a. Certain Storage Use of Home

b. Day Care Services

(1) General Requirements

(2) Special Rule for Allocation of Day Care Expenses

7. Restriction on Employee's Ability to Deduct Home Business Expenses

a. Convenience of the Employer Required

b. Rental to Employer

C. Exception for Rental Use of Home or Vacation Home

1. The Requirement of Personal Use Applied to Rental Units

2. Taxpayer Must Charge Fair Rental

3. Allocation of Expenses Between Business and Personal Use

a. Items Included in Rental Expenses

b. Rental Expense Allocation Formula

c. Expenses Allocable to Renting a Portion of Unit

4. Rental Expenses and the Gross Income Limitation

a. Gross Rental Income

b. Exception for Qualified Rental Period of a Principal Residence

5. Special Rule for De Minimis Home Rental

IV. Additional Requirements for Expenses Allowable Under § 280A

Introductory Material

A. Expenses Must Be Allowed with Respect to a Dwelling Unit

B. Expenses Must Be Allocated Between Business and Personal Use

1. Direct Expenses

2. Indirect Expenses

3. Unrelated Expenses

C. Gross Income Limit: The “Tier System” of Priority for Deducting Home Business Expenses

1. Tier 1 - Otherwise Allowable Deductions: Interest, Taxes, Casualty Losses, etc.

2. Tier 2 - Activity Expenses Not Related to Home Use

3. Tier 3 - Operating Expenses Less Than Gross Income

4. Tier 4 - Depreciation Less Than Gross Income

5. Examples

D. Expense of First Telephone Line into Home Not Deductible

E. Coordination with Trade or Business Travel Expense

V. Disposition of Property for which Expenses under § 280A Have Been Deducted

Introductory Material

A. Bifurcation Requirement for Dual-Use Property

B. Sale of Principal Residence

1. Business Use

a. Prior Law - Former § 1034

b. Current Law - § 121

(1) Exclusion of Gain

(2) Recognition of Depreciation Taken After May 6, 1997

2. Rental Use

a. Interaction with § 121

b. Bargain Rental

c. Gain or Loss from Rental Unit

VI. Interaction of § 280A with Other Code Provisions

A. Interplay with § 183 Hobby Loss Rule

B. Interplay with § 469 Passive Activity Loss Rules

C. Interplay with § 465 At-Risk Limits

D. Interplay with § 163(h) Limitation on Home Mortgage Interest Deduction

E. Effect of § 67 Floor Under Miscellaneous Itemized Deductions and § 68 Overall Limit on Itemized Deductions

F. Section 280A Does Not Limit Business Travel Deductions

VII. Compliance

A. Heavy Burden on Taxpayer to Establish § 280A Deductions

B. Home Business Deductions by Employees

C. Home Business Deductions by Self-Employed Persons

D. Home Rental Deductions


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 Committee Reports Excerpts on § 280A - Business Use of Home; Vacation Homes

Worksheet 2 [Reserved]

Worksheet 3 [Reserved]

Worksheet 4 [Reserved]

Worksheet 5 [Reserved]

Worksheet 6 Illustrative Shared Equity Financing Agreement

Worksheet 7 Illustrative Letter Regarding Convenience of Employer

Worksheet 8 Illustrative Residential Lease Involving Business Use of Home

Worksheet 9 Illustrative Contract for Goods or Services

Worksheet 10 Illustrative Independent Contractor Agreement

Bibliography

OFFICIAL

Internal Revenue Code:

Public Laws:

Legislative History:

Treasury Regulations:

Treasury Rulings:

Cases:

UNOFFICIAL

Tax Service:

Periodicals:

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