Fair Rental Days

Doing a little big of research for an extended return right now...

Taxpayer bought a condo intending to rent it out. During 2018, it was discovered that the city would not give the taxpayer a rental permit and the condo was sold because of this. Thus, 0 fair rental days and 0 personal use days.

Sec 280A focuses on the relationship between personal use and rentals days. There were no personal use days here but no rental days either. I don't think Sec 183 would apply as the taxpayer regularly does this with condos and has others that he rents out (with permits).

Are utilities and insurance able to be deducted? Drake is disallowing them with the personal use limitation worksheet but I don't know if I should trust that.

Found my answer:

viewtopic.php?f=8&t=7456&p=71383

Which of the answers in that thread did you choose?

Should be "Found an answer" above.

As the condo was never approved by the city to rent, it was never advertised for rent. No depreciation on the condo, that much I'm sure of.

Let's explore. Your "no depreciation" thought is based on its not being available for rent, and is correct.

But the proposed reg. that we are concerned about here is 1.280A-3(d)(1), the scope of which is:

(a)Scope. This section provides rules for determining the deductibility of expenses attributable to the rental of a dwelling unit used as a residence. Note that paragraph (c) of this section applies to any dwelling unit used by the taxpayer for personal purposes on any day during the taxable year, whether or not the taxpayer is treated as using the unit as a residence. See §1.280A-1 for the general rules under section 280A.

. And that's consistent with its title:

Deductibility of expenses attributable to the rental of a dwelling unit used as a residence

So can't we correctly conclude that the reg., which after all is only a proposed reg. anyway, is not applicable? I think so, because the property was not used as a residence, nor did it have personal use.

So what was its use? I think it was an investment, i.e., a capital asset held for investment purposes, on which a gain or loss on sale or exchange would be capital in nature, short or long term.

But what to do with the expenses? Not just utilities and insurance, but also taxes and interest. Are they expenses under 212? Does the limit on misc. deductions apply? Do the taxes get allowed under 164 w/o regard to the limit on investment expenses? Is the interest treated as investment interest? Is the 266 election available and, if so, should it be made?

This case is interesting and I guess has some tangential relevance, but not that much, as it involves a condo mthat was in fact used personally. https://www.kiplinger.com/members/links ... sioner.pdf

Thanks for the response Nilodop.

Time got away from me...apologies on the delayed response.

So what was its use? I think it was an investment, i.e., a capital asset held for investment purposes, on which a gain or loss on sale or exchange would be capital in nature, short or long term.

As you can probably imagine, this treatment would be unfavorable to the taxpayer as there was a loss on disposal. I'm curious about how you came to investment asset instead of trade or business asset? As mentioned above, taxpayer regularly buys and rents out condos, although he is not a real estate professional. He bought this condo with the intent to rent it out for profit and hold long-term. Wouldn't that make the condo "property used in a trade or business" and the loss on the condo 1231 despite the fact that the condo was never placed in service (according to Rev. Rul. 58-133)?

Curious about your thoughts on this or if I'm barking up the wrong tree.

Read the court case you posted... It's helpful but the fact pattern there seems to be bona fide effort wasn't made to rent out the unit. I believe I have bona fide effort with my taxpayer -- external forces made it not possible to rent, but genuine effort was made.

What I'm getting at is I think there's really two questions here...

Step 1: Is this a trade or business asset, an asset held for the production of income, or a personal use asset? I think we can easily rule out the personal use category.

Step 2: What happens to the expenses (as you noted)?

The reason I frame it like this is wouldn't step 2 be dependent on step 1? I.e. If it is a trade or business asset, wouldn't we treat expenses on the rental the same as we would treat rental expenses for a rental that has not been placed in service (but would eventually be)? And if an asset held for the production of income, the taxpayer is mostly S.O.L. because of the TCJA?

Was not aware of a Sec 266 election. Thank you for the education.

Step 0: Has the taxpayer's income-producing activity begun?

Step 0: Has the taxpayer's income-producing activity begun?

For this condo, no.

If taxpayer is in the trade or business of renting out condos, and bought this condo for use in that trade or business, wouldn't this be a 1231 asset if we applied Rev. Rul. 58-133? Surely each condo isn't a separate trade or business.

Am I being really dense here?

Surely each condo isn't a separate trade or business.

I think it depends on your facts and circumstances. I've applied the test in 1.183-1(d)(1) previously to answer this question, but perhaps some of the other contributors will have some more refined methods.

But even the expansion of an activity within a business can be treated similarly to the commencement of a new activity or business. I would suggest looking at FMR v Commissioner, 110 T.C. No. 30 (1998) for an example; also see PLR 9645002 for a counter-example with a taxpayer favorable ruling. The big distinction between your facts and both of these is that your client's expansion was unsuccessful, but I don't think that rules out a comparison.

Once these points are settled, I think the answers to your questions should follow.

wouldn't this be a 1231 asset if we applied Rev. Rul. 58-133?

That Rev Rul is a good find and has been referenced on this forum before:

viewtopic.php?f=8&t=13860

I was planning on bringing it up…but I don’t think you ever mentioned the date the condo was bought, and hence, the holding period.

I do think your foray into 280A is off-point.

At the same time, I don’t think it’s all that easy to figure out how to handle the expenses you mention. Our options are:

Capitalize to the basis of the condo;
Capitalize under 195;
Deduct as an expansion cost.

I don’t think capitalizing to the basis of the condo is appropriate. There is really no authority for that.

In terms of capitalizing under 195, we’d do that, in my view, if we are treating the one-condo rental as an anticipated/expected business unto itself. If we go this route, then we wonder about writing off the unamortized/capitalized balance. (I think the $5k allowance would be out, since the one-condo rental business never commenced). However, since the condo was actually acquired, we’re past the general/investigatory phase, meaning we are deemed to have entered into a for-profit transaction. (Expenses incurred during the general search/investigatory phase, for a business that never materializes, would be viewed as personal and non-deductible). If we are treating the one condo as a business unto itself, I don’t think we have “acquired” the business by merely acquiring the condo. We also need a lease, which is impossible to get. So, it seems to me, we’re past the general search/investigatory phase since we’ve identified a specific business, but we never acquired all the pieces necessary to conduct the one-condo rental business. In this case, we’d write-off the capitalized Sec 195 costs under Sec 165(c)(2). Sec 67(b)(3) would tell us this is a 2% deduction, which isn’t much help nowadays.

If we are treating this one condo as part of a larger business the client is already in (the residential rental business in general), then we go the expansion route and deduct the expenses on Schedule E.

If the condo was held over 1-year, I’d take a Sec 1231 loss (assuming a loss) under the RR you cite. I don’t think that result is dependent on how you handle the expenses in question.

Like I said, it’s not all that easy to figure out how to handle the expenses you mention. I’m just throwing some things out there as I see them.

If we are treating this one condo as part of a larger business the client is already in (the residential rental business in general), then we go the expansion route and deduct the expenses on Schedule E.

Let's not forget that even the expansion of an activity within a business can be treated similarly to the commencement of a new activity or business. Where section 195 doesn't apply, section 263 can still have the same effect.

Or do you have a different opinion?

Or do you have a different opinion?

No, but I think the expenses in question here – utilities and insurance (as per the OP) – are of the recurring type and of the non-long-term benefit type.

I was planning on bringing it up…but I don’t think you ever mentioned the date the condo was bought, and hence, the holding period.

Holding period was more than 1 year.

If the condo was held over 1-year, I’d take a Sec 1231 loss (assuming a loss) under the RR you cite. I don’t think that result is dependent on how you handle the expenses in question.

Exactly.

Thanks guys. I have more reading to do and I'll make a decision.

I also came across the Alamo Broadcasting Company v. Commissioner (1950) case early this morning and liked what I read there.

If the condo was acquired and prepared for rental in 2017, there's also the potential of claiming depreciation. See for example SMC Corp., 675 F2d 113 (6th Cir. 1982), in which the court held that a fully functional crane and shredder had been placed in service even though the electrical lines needed to power the equipment were not yet completed.

Of course this raises the question of whether the income-producing activity (or else, business expansion) can be said to have been completed before the permit was acquired.