Discussion:Is this interest deductible?

Is her part of the house - the separate dwelling unit that she lives in, that he's not allowed to enter - no longer part of his "residence" and is the interest on the mortgage on that part of the house no longer tax-deductible? Has that part of the interest expense become "personal interest" as defined in IRC Section 163(h)?

If I were to pose this question differently, I would ask, instead, which Section 163 exception from "personal interest" does this interest expense fall into, if any. And you would answer "it's interest on a mortgage on his principal residence, isn't it?"

But then, without even looking, I'll suggest that the "any-day-in-which-fair-rent-isn't-paid-is-treated-as-a-personal-use-day" clause is for purposes of Section 280A, or maybe even only one part of Section 280A, and I'll suggest that it therefore doesn't reach Section 163(h) which is, I think, where we're at, so to speak, to not end a sentence with a preposition but with a split infinitive.

And thus, when the Code says "deductions that are otherwise allowable" we've lost the deduction for the interest cuz the dwelling unit [maybe] lacks "residence-ness" for the owner and the interest *isn't* "otherwise allowable".

Maybe the nitty-gritty of this issue is what's the definition of "residence-ness" for Section 163(h)...? But over and over and over we've been clubbed with "the definition of residence is facts and circumstances, Donny."

Where I'm at is asking whether this can be a "residence" of the taxpayer *at all* considering that he's not allowed to be there...

And @Podolin, I'm pretty sure that an ex-wife isn't considered "family" like parents and kids...

Okay, I catch your drift. Your argument is that the personal use imputed to the taxpayer, by virtue of allowing someone to stay "rent free" in a portion of the residence, is only for purposes of Sec 280A. Therefore, you suggest that the taxpayer never truly used the tenant's portion of the residence at all during the tax year, meaning that the taxpayer had no "true" personal days with respect to the tenant's portion of the home (all the taxpayer had were personal days imputed to him under 280A). Then, you further suggest that since the taxpayer had no true personal use days of the tenant's portion of the residence, said portion of the overall residence may not qualify as a "residence" for 163 purposes.

If this is your theory, I ask: Where is the kitchen?

So we look at sec. 163(h)(4)(A)(i)(II) and that leads us to sec. 280A(d)(i) for the definition of a residence. That says, in relevant part:

   "For purposes of this section , a taxpayer uses a dwelling unit during the taxable year as a residence if he uses such unit (or portion thereof) for personal purposes for a number of days which exceeds the greater of—"

So now we have to ask ourselves what a "dwelling unit" is. We find that in 280A(f)(i):

  "For purposes of this section —

   280A(f)(1)(A) In general. The term “dwelling unit” includes a house, apartment, condominium, mobile home, boat, or similar property, and all structures or other property appurtenant to such dwelling unit. 

   280A(f)(1)(B) Exception. The term “dwelling unit” does not include that portion of a unit which is used exclusively as a hotel, motel, inn, or similar establishment."

I suggest that the exception in (B) does not apply. So we are left with "a house...and all structures or other property appurtenant to such dwelling unit." Can the area in which the ex lives be described as appurtenant to your buddy's residence?

according to your post. The agreement that she uses an exclusive portion of the house appears to be no more than a self-imposed restriction on the owner and can be rescinded at any time. It seems more of a gratuitous license to use a portion of the home.

In any event, IRS Publication 527 Residential Rental Property pg.21 clarifies the issue under the section "What is a day of personal use?", example 4 which states:

"You own a property that you rent to your son. Your son does not own any interest in this property. He uses it as his main home and pays you a fair rental price. Your son's use of the property is not personal use because your son is using it as his main home, he owns no interest in the property, and he is paying you a fair rental price"

In addition pg. 21 states "A Fair rental price for your property generally is the amount of rent that a person who is not related to you would be willing to pay. The rent you charge is not fair rental price if it is substantially less than the rents charged for other properties that are similiar to the property in your area."

Absent fair rental payments, the home is 100% personal use and the interest is fully deductible as home mortgage interest. No portion of interest should be limited.

Sec. 121(d)(3)(B)

Were it not for that nasty 'Solely for the purpose of this section,' this might solve all the problem.

@Gsnook - Harry's point is that a day of personal use under the 280A rules applies for 280A purposes only. Read the entire thread. I.E. if ex-wife does indeed have a separate dwelling unit inside taxpayer's residence, and she pays $0 rent, we agree that, for 280A purposes, we have personal use days imputed to the taxpayer - for Sec 280A purposes. But do these imputed personal use days count as "actual" personal use days when determining if a dwelling unit counts as a residence? Harry says "no."

@Death - No mention was made of this arrangement being part of a divorce or separation instrument. And I think you're just quoting part of the "use" test for the 2-out-of-5-year rule.

And don't miss the "if-it's-not-rented-the-more-than-fourteen-days-personal-use-requirement-in-280A-no-longer-applies" item in the "what's a second residence" definition...

Based on the facts presented, is this dwelling unit rented to the ex- at a zero rent, or is it not rented at all?

There are two complete kitchens, FWIW.

Well, you have now clarified that we do indeed have two dwelling units within the same residence.

So, we now go back to Harry's question:

Based on the facts presented, is this dwelling unit rented to the ex- at a zero rent, or is it not rented at all?

It's not rented at all per Reg § 1.163-10T(p)(3)(iii):

Use as a residence. If a residence is rented at any time during the taxable year, it is considered to be used as a residence only if the taxpayer uses it during the taxable year as a residence within the meaning of section 280A(d). If a residence is not rented at any time during the taxable year, it shall be considered to be used as a residence. For purposes of the preceding sentence, a residence will be deemed to be rented during any period that the taxpayer holds the residence out for rental or resale or repairs or renovates the residence with the intention of holding it out for rental or resale.

And, per the above reg, and also pursuant to Sec. 163(h)(4)(A)(iii):

(iii) Residence not rented. For purposes of clause (i)(II) , notwithstanding section 280A(d)(1), if the taxpayer does not rent a dwelling unit at any time during a taxable year, such unit may be treated as a residence for such taxable year.

And I guess you just didn't trust me when I said the ex-wife has a separate "dwelling unit" that she lives in. If I *hadn't* put it in quotes, would you still have asked about the second kitchen?

Did those Redskins do a bang-up job or what?

Chris, I agree we are of one mind on this one. Lets see if Professor Boscoe agrees.

True. If taxpayer didn't hold the ex-wife's dwelling unit out for rent, then the -10T(p) reg says it fails as a deemed rental.

So, your question is now this: Is the arrangement with ex-wife, wherein she pays $0 rent a "rental?" Probably not, but you haven't given us all the facts.

Is there a written lease that says ex-wife will pay $0 rent? Why is the taxpayer undertaking this arrangement in the first place - there's got to be a reason, what is it? Does the ex have no money and taxpayer doesn't want her out in the street, so taxpayer gives her use of his property out of the kindness of his heart? Is wife paying any utilties, etc.? Would wife have any state/local rights under tenant/landlord law? Again, you haven't given us all the facts. But common sense tells us that when someone pays $0 rent, with no written lease, with no specified lease term, to someone they get along with in some capacity, its not a rental arrangement - it's a gift. But again, you haven't told us about the relationship between taxpayer and ex-wife.

And I guess you just didn't trust me when I said the ex-wife has a separate "dwelling unit" that she lives in. If I *hadn't* put it in quotes, would you still have asked about the second kitchen?

I just wanted it clarified in case you hadn't considered it.

I already cited the rule above about someone that doesn't rent a dwelling unit. If there's no rental, or deemed rental, then there's no problem with the deduction. If there is rental arrangement, then the taxpayer has to actually use the residence within the meaning of Sec 280A(d).

And to Harry: IRS would say there's a rental arrangement. There's a valid lease and rent is paid. Taxpayer would argue that there is no lease - but a gift. This is a case based on facts and cirumstances.

He gets the check, which is taxable rental income, and *then* he makes a gift to his ex- by not depositing the check.

Sounds like just an every-day kinda thing between ex-spouses to me...

I know that the case in the OP states that this is "arrangement", but later it is defined as a formal lease and gift. This takes the steam out of the discussion.

I would like to go back and discuss what if this was a formal arrangement established in the property settlement (which would be strange). Or what if this was just an informal arrangement that can be revoked?

If my daughter slams her bedroom door in my face and tells me I can't come in, do I have to stop taking deductions for that part of the house?

Sec. 163(h)(4)(A)(i)(II) says in order to qualify as a second residence, a property must be used as a residence by the taxpayer within the meaning of Code Sec. 280A(d)(1). 280A(d)(1) says:

For purposes of this section , a taxpayer uses a dwelling unit during the taxable year as a residence if he uses such unit (or portion thereof) for personal purposes for a number of days which exceeds the greater of— (A) 14 days, or (B) 10 percent of the number of days during such year for which such unit is rented at a fair rental.

...We've always had this divergence with 163 and 280A, it's nothing new. Sec 163 says the "property" must be used as a "residence." Sec 163 then sends us to 280A, to determine if the "property" was used as a "residence." But when we get to 280A, the word "property" disappears and is replaced by "dwelling unit" (i.e. "a taxpayer uses a dwelling unit as a residence if..."). In essence we move from "property" in 163 to "unit of property" in 280A. Again, this is nothing new. Most commentators agree that this shift was intentional so as to contemplate situations in which a single property may house more than one dwelling unit. As such, most commentators agree that we need to go by the 280A definition since this is what 163 tells us to do. In other words, we can take the cross-reference from 163 to 280A in one of two ways (1) First, we could argue that it's a meaningless, invalid cross-reference that has no effect since 163 refers to a "property" being used as a "residence" and the definitional language in 280A does not refer to a "property" being used as a "residence" (instead, it refers to a "dwelling unit" being used as a residence or (2) Second, we can take the cross-reference as a valid cross reference and must go by the 280A definition, despite the shift from "property" to "dwelling unit." Most commentators agree that the cross-reference is a valid cross-reference.

Of course, if the unit was never rented or deemed rented, it automatically qualifies as a 2nd residence and the above usage rules are inapplicable.

Or, better yet, the IRS might say "rent paid and received and taxable" and it's a rental subject to Section 280A and the interest expense is then a rental deduction, subject to the passive activity loss limitations.

Yes, of course the IRS "might" assert this. But, assuming that the rent is fair rent, we'd have zero personal days, meaning that 100% of the expenses associated with the ex's dwelling unit would be allowable, including the interest, taxes, depreciation, etc...and the net result would be subject to the passive rules. And, if you don't like this result, you can make the gift argument and assert (1) that the taxpayer tore up the lease (2) never accepted the rent payments and, therefore, (3) there was never a rental arrangement to begin with, which case (4) the ex's dwelling unit qualfies as a 2nd residence by default since it was never rented.

He gets the check, which is taxable rental income, and *then* he makes a gift to his ex- by not depositing the check

Or, as noted above, your argument would be that the taxpayer tore up the lease and never accepted a single rent payment. Therefore, the gift was not a gift of deemed cash back to the ex, but was a gift in the form of rent-free usage of the dwelling unit. In other words, if there's no rental arrangement, payments from the ex to the taxpayer were made in error.

I still say it is appurtenant to the main part of the house and, therefore, it is all the one residence for the purposes of sec. 163.

Not sure you know what appurtenant means. In this case, the ex's dwelling unit is not "appurtenant" to the main home (b/c its not an appurtenant structure - it is part of the main home.

From Reg. 1.121-1(e):
"Section 121 will not apply to the gain allocable to any portion (separate from the dwelling unit) of property sold or exchanged with respect to which a taxpayer does not satisfy the use requirement. Thus, if a portion of the property was used for residential purposes and a portion of the property (separate from the dwelling unit) was used for non-residential purposes, only the gain allocable to the residential portion is excludable under section 121. No allocation is required if both the residential and non-residential portions of the property are within the same dwelling unit."

I apologize if this flash of insight doesn't fit right in with the flow of the discussion, but you'll get over it, won't you?

I learned what appurtenance means when I qualified as an association football referee in 1983.

Next question: in this case, is the granny flat *eligible* to be chosen as the second residence of the taxpayer w/r/t the deductibility of his home mortgage interest?

That portion of the reg doesn't define principal residence. And I think you need to take a look at the last Example 3 from the 1.121-1 regs. In Harry's case, the one property has two dwelling units - akin to a duplex. And the unit not lived-in/used by the taxpayer wouldn't be considered to be a "portion" of the taxpayer's primary residence for 121 exclusion purposes (i.e. an allocation would be required).

But for interest deduction purposes, the only way to get a deduction would be for the ex's dwelling unit to qualify as a second residence.

"Automatically qualifies" is pretty strong, isn't it?

I believe the Code says that in such a case, the property/dwelling unit may be a residence. Thus leaving *other* criteria to determine whether or not it is a residence

And while I can remember it, I think this "valid cross-reference" establishes a threshold for "personal use" that is *required* for the dwelling unit/property to be used as a residence in situations where it *is* also rented.

That's right. So in your case, if you argue that the ex's dwelling unit was never "rented" (or deemed rented) to her or anyone else, then the "personal use threshold" rule in 280A doesn't apply. So, IN YOUR CASE, seeing that the ex's dwelling unit is attached to the taxpayer's dwelling unit, it is undisputable that the ex's dwelling unit would qualify as a second residence of the taxpayer.

"Automatically qualifies" is pretty strong, isn't it?

I believe the Code says that in such a case, the property/dwelling unit may be a residence. Thus leaving *other* criteria to determine whether or not it is a residence

Harry, you can get into all these semantics if you want to. Or you could use some logical reasoning of the rules and apply them to your situation. Are you telling me that we now have to do some further investigation to decide if the ex's dwelling unit qualifies as a second residence of the taxpayer if it was never rented? If so, do the analysis and please tell everyone specifically why it wouldn't qualify as a second residence.

"You converted the basement of your home into an apartment with a bedroom, a bathroom, and a small kitchen. You rented the basement apartment at a fair rental price to college students during the regular school year. You rented to them on a 9 month lease (273) days. You figured 10% of the total days rented to others at fair rental price is 27 days. During June (30 days), your brothers stayed with you rent free. Your basement was used as a home because you used it for personal purposes for 30 days. Rent-free use by your brother is considered personal use. Your personal use (30 days) is more than the greater of 14 days or 10% of the total days it was rented (27 days)."

Page 21 of the publication also states that a personal use day also applies to "anyone at less than fair rental price".

This example clearly addresses a taxpayer's residence that contains more than one dwelling unit within it. Based upon that example, and other examples in that publicaton, I think it is a reasonable and supportable position that the interest in Harry's client's case would be fully deductible as mortgage interest on the taxpayer's main home (not second home). Interest on a main home that contains multiple dwelling units within it would be interest on a main residence unless rent enters into the equation. Absent rent, interest on a main home does not cease to be interest on a main home merely because it has another dwelling unit within it, and in which someone is being allowed to occupy that dwelling in act of generosity. I think the publication adds additional clarity and practicality where the code and regulations quoted thus far leave off.

Page 21 of the publication also states that a personal use day also applies to "anyone at less than fair rental price".

This is a 280A(d)(2)(C) rule that applies for 280A pigeon-hole/categorization purposes only.

Also, the example you cite from the Pub (Example 1 on Page 22 of Pub 527)...makes it clear, immediately before this Example is given, that: "The following examples show how to determine whether you used your rental property as a home." It doesn't say anything about how the interest on Schedule A "may" be deducted - as primary residence or second residence. This is something you're guessing at.

So it would seem it boils down to whether the ex-wife's use is considered rent or gift or what?

You may have overlooked "Page 21 of the publication also states that a personal use day also applies to "anyone at less than fair rental price". Of the criteria for a personal use day, related party relationships and personal days is noted in #2 on pg 21. On the same page, #4 addresses a non-related party at "less than fair value".

"Also, the example you cite from the Pub (Example 1 on Page 22 of Pub 527)...makes it clear, immediately before this Example is given, that: "The following examples show how to determine whether you used your rental property as a home." It doesn't say anything about how the interest on Schedule A "may" be deducted - as primary residence or second residence. This is something your guessing at."

The first paragraph on pg. 21 Chapter 5 of the publication explicitly states "In this chapter, we are looking at rental activities where the same dwelling unit is used as both your home (or is considered to be your home) and as a rental". If you do not rent your main home or any portion of it, how you think that the mortgage interest is not fully deductible on sch. A as interest on a primary residence?

In your threads you have cited may code sections but have not really given your position on whether you think the interest is on a main or second home. If you have a main home with another dwelling unit within it, and it is not rented, then what is the issue that still remains for you? I mentioned that it appears no more than a gratuitous license to use a portion of his home and you mentioned that it appears to constitute a "gift". Whether a license or gift, it is fully deductible interest as main home.

"The following examples show how to determine whether you used your rental property as a home." It doesn't say anything about how the interest on Schedule A "may" be deducted - as primary residence or second residence.

You are not always going to find an example that mirrors a taxpayer's exact position. But what makes you question whether a second home exists within the main home? Do you think that if someone has a home with multiple kithchens and bathrooms, and which is not rented, that it constitutes a main home and a second home? If someone has a large custom home and puts multiple kitchens in it , would you advise your client that he/she has two homes?

If you think that the code and publications are ambiguous and do not answer the question for this taxpayer, then judgement needs to step in. Is the position that the interest is fully deductible as a primary residence unreasonable? If so, why? Does splitting the home into a main home and a second home seem more of a reasonable position?

Taking a position is not guessing.

I think so...and I think some are arguing that, hypothetically, if the ex's dwelling unit was not occupied by the ex-wife (and was not rented to anyone...and let's say physically used only by the taxpayer all year), that the interest expense related thereto could be deducted as "primary residence" interest as opposed to second residence interest.

I'll dispute that. To be a second residence, it seems to me that a dwelling unit must first be a residence. And for it to be a residence, it seems *logical* - oops! - that it would need to be occupied or used or at least available for use by the taxpayer. The ex-wife's dwelling unit isn't any of those.

There, I dispute your indisputability. Which might be close to being impertinent about appurtenance...

Well, actually, that's *just exactly* the question that I've posed, although quite roundaboutly.

I am asking whether the "rules" found in the Code and the Regs and in whatever rulings we might find applicable answer this question. Or are we expected to apply **logic** to find a good answer?

Any takers? Do the Code and Regs provide an adequate structure to determine the deductibility of the interest on the "second dwelling unit" in my buddy's house? [He's more a buddy, and less a client. I hope you won't hold that against him.]

You can even *change the facts* just gently, but only if you're really careful about it.

(iii) Residence not rented. For purposes of clause (i)(II) , notwithstanding section 280A(d)(1) , if the taxpayer does not rent a dwelling unit at any time during a taxable year, such unit may be treated as a residence for such taxable year.

The "may" is in there b/c the taxpayer needs to "elect" to claim it as such.

But please note that in this sub-sub-sub-sub section, the dwelling unit "may be *a residence*" rather than "may be *a second residence*." I think we're talking about being a residence vs. not being a residence...

This provision says only that the required 15 days or whatever is *not* the threshold for the dwelling unit to be a residence (in a year that it's "not rented").

And the $64K question is: What's the threshold for a "property" to be a "residence"?

Here's the code itself: (iii) Residence not rented. For purposes of clause (i)(II), notwithstanding section 280A(d)(1), if the taxpayer does not rent a dwelling unit at any time during a taxable year, such unit may be treated as a residence for such taxable year. The "may" is in there b/c the taxpayer needs to "elect" to claim it as such.

I agree.

The taxpayer *elects* to treat a residence as a *second* residence.

IMHO, it has to be a "residence" first and *then* the taxpayer may elect it to be his "second residence".

I don't know how many other ways I can say this...

You guys are missing the point. The "may" doesn't mean "the unit MAY or MAY not be a residence," as Harry suggests. It means "The unit MAY be treated as a residence if the taxpayer elects for it to be treated as a residence." The Code Section at play says "for purposes of clause (i)(II)" - Clause (i)(II) is the specific section that deals with the taxpayer being able to select one other residence for which he wishes to claim a mortgage interest deduction. Also, the "may" doesn't mean "the unit MAY or MAY not be a residence" because it's a given that its already a dwelling unit ("if the taxpayer does not rent a dwelling unit at any time during a taxable year, such unit may be treated as a residence for such taxable year").

Moreover, the reg on the issue says this: If a residence is not rented at any time during the taxable year, it shall be considered to be used as a residence.

But please note that in this sub-sub-sub-sub section, the dwelling unit "may be *a residence*" rather than "a second residence." I think we're talking about being a residence vs. not being a residence...

Where are you quoting this from. I don't get it.

This provision says only that the required 15 days or whatever is *not* the threshold for the dwelling unit to be a residence.

What provision?

And the $64K question is: What's the threshold for a "property" to be a "residence"?

From my post above:

Sec. 163(h)(4)(A)(i)(II) says in order to qualify as a second residence, a property must be used as a residence by the taxpayer within the meaning of Code Sec. 280A(d)(1). 280A(d)(1) says:

For purposes of this section , a taxpayer uses a dwelling unit during the taxable year as a residence if he uses such unit (or portion thereof) for personal purposes for a number of days which exceeds the greater of— (A) 14 days, or (B) 10 percent of the number of days during such year for which such unit is rented at a fair rental.

...We've always had this divergence with 163 and 280A...which I explained above.

Sure he does. If the dwelling unit constitues a residence.

The taxpayer *elects* to treat a residence as a *second* residence.

Right. And 163 directs you to 280A, which flips the language around and gets into the concept of "dwelling unit."

Later we find "In the case of a taxpayer who owns more than two residences, the taxpayer may designate each year which residence (other than the taxpayer's principal residence) the taxpayer wishes to have treated as the second residence."

"Designate," not elect.....but of course, this is where the tp has three or four 'residences.

This is ancient history, but it gives background to the intent.

I think Chris is right on the money with his interpretation of 'may.'

"Where are you quoting this from. I don't get it."

This is part of the statutory definition of "qualified residence"; it's found at IRC Section 163(h)(4)(A)(iii):

"(iii) Residence not rented .. For purposes of clause (i)(II), notwithstanding section 280A(d)(1), if the taxpayer does not rent a dwelling unit at any time during a taxable year, such unit may be treated as a residence for such taxable year." [emphases added]

  A property has to be a residence before it can be a second residence.  But if it's not rented, it can be [..it may be..] a residence even if it's not "used as" a residence under the Section 280A test, because that test doesn't apply to "things" that haven't been rented during the year...

"(II) 1 other residence of the taxpayer which is selected by the taxpayer for purposes of this subsection for the taxable year and which is used by the taxpayer as a residence (within the meaning of section 280A(d)(1) )."

"Selected" is closer to being designated that being elected, as in the words 'picked out.' He selected a suit; he picked out a suit.

Can you trust the Blue Book? The Tax Court often goes there to see what the people of 25 years ago meant.

I also note the word 'treated' in 'treated as a residence.'

Please tell us what your point is as it specifically relates to your situation.

Are you asking how one uses a piece of property, or a dwelling unit, so as to qualify it as a "residence?"

I'm pretty sure you know where I'm trying to go: for a dwelling unit that isn't rented where is the *rule* for what's considered in determining whether it's the owner's residence or not.

When it's rented, we have a rule. When it's not rented, there's not a rule, not yet, not that I can find.

I say "yes" on the grounds that the separate dwelling units for the ex's are irrelevant. Taxpayer uses the property/residence...and he's merely letting a few friends use it as well.

I agree, this is a 280A rule. But there's some logic to it. If you let someone stay in a unit rent free, you're serving a personal/gratituous purpose, not a rental/make money purpose. I think the same logic is part of the analysis that goes into the case at hand.

Admittedly, if the taxpayer is out of town for extended periods of time, residing in a vacation home in Hawaii, he'd be hardpressed to argue that ex's personal use of his primary residence is tantamount to his personal use. But if he's there at the primary residence - using his unit regulary, I think it's more than logical to ignore the fact that ex has a dwelling unit. What's more logical - since this is a facts and circumstances determination - is to see if the guy is using part of the property, and if he is, that's good enough. The fact that ex lives there (rent free) is just an extension/manifestation of taxpayer exercising his right to have a friend stay there.

Admittedly, if the taxpayer is out of town for extended periods of time, residing in a vacation home in Hawaii, he'd be hardpressed to argue that ex's personal use of his primary residence is tantamount to his personal use. But if he's there at the primary residence - using his unit regularly, I think it's more than logical to ignore the fact that ex has a dwelling unit. What's more logical - since this is a facts and circumstances determination - is to see if the guy is using part of the property, and if he is, that's good enough. The fact that ex lives there (rent free) is just an extension/manifestation of taxpayer exercising his right to have a friend stay there.

(3) Second residence —(i) In general. The term “second residence” means—

(A) A residence within the meaning of paragraph (p)(3)(ii) of this section,

(B) That the taxpayer uses as a residence within the meaning of paragraph (p)(3)(iii) of this section, and

(C) That the taxpayer elects to treat as a second residence pursuant to paragraph (p)(3)(iv) of this section.

A taxpayer cannot have more than one second residence at any time.

(ii) Definition of residence. Whether property is a residence shall be determined based on all the facts and circumstances, including the good faith of the taxpayer. A residence generally includes a house, condominium, mobile home, boat, or house trailer, that contains sleeping space and toilet and cooking facilities. A residence does not include personal property, such as furniture or a television, that, in accordance with the applicable local law, is not a fixture.

(iii) Use as a residence. If a residence is rented at any time during the taxable year, it is considered to be used as a residence only if the taxpayer uses it during the taxable year as a residence within the meaning of section 280A(d). If a residence is not rented at any time during the taxable year, it shall be considered to be used as a residence. For purposes of the preceding sentence, a residence will be deemed to be rented during any period that the taxpayer holds the residence out for rental or resale or repairs or renovates the residence with the intention of holding it out for rental or resale. [emphasis added]

Does anyone else see how redundant the statement "If a residence is not rented at any time during the taxable year, it shall be considered to be used as a residence is? What it comes down to is "A residence (totally undefined) will be treated as used as a residence." The folks who wrote this were struggling.

And there it is, too, the **election** of a second residence that one of us suggested didn't exist.

"(ii) Special rule for rental of residence. If a taxpayer rents a portion of his or her principal or second residence to another person (a “tenant”), such portion may be treated as used by the taxpayer for residential purposes if, but only if—

(A) Such rented portion is used by the tenant primarily for residential purposes,

(B) The rented portion is not a self-contained [what does "self-contained" mean?] residential unit containing separate sleeping space and toilet and cooking facilities [did someone say "dwelling unit"?], and

(C) The total number of tenants renting (directly or by sublease) the same or different portions of the residence at any time during the taxable year does not exceed two. For this purpose, if two persons (and the dependents, as defined by section 152, of either of them) share the same sleeping quarters, they shall be treated as a single tenant." [emphasis added]

If it's rented, a self-contained dwelling unit within the taxpayer's house [granny flat] is *not* allowed to be treated as part of that house, as part of the owner's principal residence, is what this says. I think that's what this says.

I suggest that this reg may "almost" answer the question about the ex-wife's space in my buddy's home because this reg provides an answer when a *rented* part of the residence is *not* a separate "dwelling unit" within the taxpayer's residence, and in doing so, provides an answer for when a *rented* part of the property *is* a separate "dwelling unit." But the reg falls short of addressing the same question when the separate "dwelling unit" *isn't* rented, but is made available "for free". However, it is clear from this regulation that a "part of the residence" is a different animal from a "separate dwelling unit."

Why limit the discussion to second residences? I buy 50 acres of land here in the Pine Barrens, and on this land is a 2000 square feet house, like the one I own now. I finance the purchase; the mortgage company records the debt and I seemingly have a personal residence for I use the land for nothing except to permit my grandkids to come and camp on it. Seems to be covered by Reg. 1.121-1(b)(3), for 163(h) defines principal residence interest by Sec. 121. The Reg does give the standard 'facts and circumstances' clause, but that is in reference to a sale of the property, not the deductibility of the debt on same.

I could then buy the adjoining 50 acres with small house and let my sister live there; she has no money but needs a place to stay. Here I have to meet the definitions under 280A, but I should be okay.

Yet, unless I am a total recluse, can anyone think that I am buying primarily nothing more than land in both cases? And that the debt is financing the purchase of land?

btw: as to the man living a year in Hawaii, this comes into play when defining qualified relative also under Section 152(d)(2)(H)....."has the same principal place of abode as the taxpayer and is a member of the taxpayer's household." On audit, I had a person lose a dependency for his 'squeeze' because he spent the year living in Pittsburgh while his principal residence was occupied by that person, who met every other qualification for dependency.

And to D&T, my mind is wandering in the same general direction (hence my example of 1 "residence" with 21 dwelling units).

The Reg does give the standard 'facts and circumstances' clause, but that is in reference to a sale of the property, not the deductibility of the debt on same

I agree...but I'm not so sure I would toss it out as irrelevant. The 121 regs are the only place where "principal residence" is somewhat defined.

Letting others occupy the property/other dwelling unit rent-free is personal use and that makes the property/other dwelling unit part of the homeowner's residence if that definition applies. I don't think it does.

I agree, that's why I modified the definition, so as to make it more of a facts and circumstances analysis. In other words, what I'm saying is this: If the taxpayer uses his portion of the residence regularly, as his principal residence, and lets a "fried" stay rent-free in a separate dwelling unit that is part of the same residence, I would argue that the taxpayer is indeed using the entire property as his primary residence.

Similarly, if the taxpayer does not regularly use his portion of the residence, but does allow a friend to stay rent-free in a dwelling unit that is part of the same residence, I would say friend's usage of a separate dwelling unit within the same residence does not result in the taxpayer using the property as a primary residence. (But in this case, I would suggest that the entire residence could be a 2nd home).

And keep in mind, as Harry has pointed out, Sec. 163(h)(4)(A)(i)(II) (which sends us to 280A(d)(1)), deals with a 2nd residence. As such, if we're trying to determine if a taxpayer uses his primary residence as a residence, this Code Section is not where we need to look.

Sure, one can have two or more "second residences" - but interest can only be deducted on one of them, based on the taxpayer's election, selection, designation, 1040 reporting.

Code Sec. 163(h)(4)(A)(i)(II);

(A)  Qualified residence. 

(i) In general. The term “qualified residence” means— (I) the principal residence (within the meaning of section 121 ) of the taxpayer, and

(II) 1 other residence of the taxpayer which is selected by the taxpayer for purposes of this subsection for the taxable year and which is used by the taxpayer as a residence (within the meaning of section 280A(d)(1)).

Three different sources offer three different exceptions to that rule!

Just so nobody will be fooled into thinking that "used as a residence" is part of the *definition* of a "residence," here's what the Code and the Regs and the Blue Book say about that notion:

According to the Code:

“For purposes of clause (i)(II), notwithstanding section 280A(d)(1), if the taxpayer does not rent a dwelling unit at any time during a taxable year, such unit may be treated as a residence for such taxable year.”

According to the Regs:

“If a residence is not rented at any time during the taxable year, it shall be considered to be used as a residence.”

According to the Blue Book:

“If a second residence is not rented at any time during the taxable year, the taxpayer need not meet the requirement of Section 280A(d)(1) that the residence be used for personal (non-rental) purposes for the greater of 14 days or 10 percent of the number of days it is rented.”

[emphasis has been added simply to attract the reader's attention to the inconsistencies in these three "authoritative" descriptions of *the same provision*...

"I'm from the government; I'm here to help you." ]

"(3) Qualified residence interest. For purposes of this subsection —

(A) In general. The term “qualified residence interest” means any interest which is paid or accrued during the taxable year on—

(i) acquisition indebtedness with respect to any qualified residence of the taxpayer, ...."

and after a mention of home equity interest in (ii), we come to

"For purposes of the preceding sentence, the determination of whether any property is a qualified residence of the taxpayer shall be made as of the time the interest is accrued."

But after we look at 163(h)(4) and its Section 121 reference, I suppose we have to come to the conclusion that "any" isn't really 'any' but must contain the principal residence of the taxpayer, as Chris notes. I would imagine all of us have had situations where principal residence is practically paid off, interest is very small, but client has two other properties used for vacation and for college student and the interest on them would benefit the client.

In other words, interest expense on Vacation Home #2 and Vacation Home #3 fails as a deduction, not because of the code section you cited, but only thereafter...after the taxpayer "elects" to deduct the interest on Vacaction Home #1.

Why is that relevant? And keep in mind that if others later review this post and find a few things to take away, then maybe they can bill for their time in pulling up the post and reviewing it.

in the context of issues that are encountered thousands of time across the taxpaying U.S.

How often does a taxpayer have 1 primary residence that contains 2 separate dwelling units...one of which the taxpayer uses personally and the other of which he allows a "friend" (an unrelated party) to use and which the taxpayer is prohibited from using?

Does the ex's dwelling unit count as part of the taxpayer's primary residence for 163 purposes? Or must taxpayer treat the ex's dwelling unit as a second residence, only to deduct related interest as second home interest?

We have had several lengthy discussions on the word "such" and how to interpret it. Or go to Harry's 'summer class' last year, about the backhoes and the deductibilty of interest with or without an election under 1.163-10T. These discussions are not wasted, and there have been a number of times when a bulb has gone off in my mind when trying to answer a question and I check back here.

WK_Case _ Tax Court Memoranda (Archive), Gertrude C. Gorod, et al v. Commissioner, U.S. Tax Court, CCH Dec. 38,388(M), T.C. Memo. 38,388(M), 42 T.C.M

Below is a summary of a parts of the case that may be relevant, as well as excerpts that coincide with some of the situations discussed in the scenario at hand:

"The taxpayer, who had constructed a duplex apartment building and who occupied the upper unit of the building, held the lower unit for the production of income despite the fact that the lower unit had never been rented. Accordingly, she was entitled to deduct depreciation, repair, and maintenance expenses incurred in connection with the lower unit. Also, she was entitled to casualty loss deductions in amounts determined by the Court for damage to the building by vandals. Finally, she was entitled to a deduction for her payment of real property taxes."

"Findings of Fact

"Petitioner Gertrude C. Gorod (hereinafter petitioner) resided at 371 Bryant Street, Malden, Massachusetts, when she filed her petitions in these cases. Petitioner constructed a duplex apartment building (hereinafter building) in 1968 and occupied the upper unit from 1968 through the taxable years at issue. The building is located in a run-down area of the City of Malden. The lower unit was made available for rental in 1968, and continued to be so held through the taxable years at issue. However, due to the location of the building petitioner has not been able to rent the lower unit at any time since it was built. No tenants were found even though petitioner repeatedly advertised the unit in the newspaper and posted notices in area supermarkets. Several individuals have responded to the advertisements and notices over the years, but they decided to seek living quarters elsewhere. At no time was the lower unit occupied by petitioner, although she did enter it perodically to make sure the premises were secure and to make repairs."

"Petitioner determined the amount of the utilities, insurance and landscaping expenses by allocating one-half of the total cost to the lower unit. The painting and repairs expenses represent amounts actually expended by petitioner on the lower unit. The building was constructed at a cost of $35,000, exclusive of land, with a useful life of 25 years. One-half of the cost of construction is allocable to the lower unit. Petitioner claimed a depreciation deduction for the lower unit in the amount of $1,500 on her 1976 and 1978 Federal income tax returns."

"Opinion"

Respondent contends that petitioner's failure to rent the lower unit establishes that the activity was not engaged in for profit. While the lack of rental income is an indication that the activity is not engaged in for profit, it is just one factor of many that must be considered in resolving this issue. Petitioner's lack of rental income is explained by the fact that the building is located in a high crime, run-down area. Petitioner still advertised the lower unit for rent in the newspapers and in supermarkets, and expected to rent it at some time in the future. Petitioner spent money keeping the lower unit in a habitable condition, and did not use it for her own purposes. In addition, the building was designed and constructed as two separate housing units. All of this leads us to conclude that the lower unit of the building was property held for the production of income, and that the expenses incurred in connection therewith are deductible pursuant to section 212. Respondent also contends that section 280A precludes the deduction of the rental expenses and depreciation, apparently on the theory that petitioner's occupancy of the upper unit constitutes “personal use of the lower unit. We need not delve into the intricacies of section 280A, however, because we note that the building consisted of two separate and distinct dwelling units, and petitioner only entered the lower unit to make repairs and to check security. Under such circumstances we find section 280A inapplicable. 6 Respondent further contends that petitioner failed to substantiate the expenses. Petitioner introduced documentary evidence and provided detailed testimony on the various expenses, and we are convinced that petitioner did incur expenses in the amount she claimed. However, some adjustment is necessary to the utilities expense deduction since the unit was unoccupied throughout the years at issue. Using our best judgment, we find that one-fourth of the total utilities expenses ( i. e., one-half of the amount petitioner allocated to the rental unit) are allocable to the rental unit. Also, petitioner's depreciation deduction is limited to $700 per year (one-half of $35,000, the cost of construction, divided by 25 years, the useful life of the rental unit).

I don't know if this is of any help, but it is the only case I was able to find that deals with 1 structure and more than 1 dwelling unit. Although is deals with the property being held for rental, it does correlate with issues in Harry's case. The IRS did seem to argue that the basement was personal use attributable to personal use of the petitioner, but does not mention anything about a second home vs. a primary home.

Hope this was of some use!

Upon re-reading my post, I can see some room for me to clarify and simplify. (But don't I even get credit for the alliteration?). My criticism is of the system - especially the tax policymakers and their staffs. I sincerely believe the system can and should be simplified. The simplification effort should be pushed by professional organizations such as AICPA, ABA, etc. The general public would be supportive and the politicians might even listen. Is it as high a priority as the economic and tax issues currently in the news? Of course not, but it has a place in the pecking order at the right time.

I agree with you. However, do you think the IRS's position "Respondent also contends that section 280A precludes the deduction of the rental expenses and depreciation, apparently on the theory that petitioner's occupancy of the upper unit constitutes “personal use of the lower unit. gives insight into how (the IRS) they may view the matter that Harry has presented? In other words, that the multi-dwelling unit in his case constitutes one residence with interest being taken as interest on a primary residence, rather than toward a second home? I pulled the case from CCH online research and their notes on a taxypayer's primary residence substantition was interesting. They said that the courts will look, among other things, at the taxpayer's address listed for bills, tax returns, etc. (any many other criteria) to determine a taxpayer's primary residence. If Harry's client has only one residential address for the unit, and without a separate mail box, it could lend weight that the dual dwelling unit can be considered "one residence" for purposes of interest, rather than two residences. I think there might be more weight to a second residence argument if their were two addresses and mailboxes, and/or whether Harry's client's residence was designed to be two separate housing units. That seemed to be an important distinction in the court case.

"apparently on the theory that petitioner's occupancy of the upper unit constitutes “personal use of the lower unit."

One final point on the quote from the court case I mentioned above. The IRS is attributing personal use on the lower unit to occupancy of the upper unit which was used as the taxpayer's main home. This is my interpretation, but I think that this lends weight that the IRS is not looking at the lower unit as a second residence, since it is occupancy of the "upper portion" (main residence) that creates the "personal use of the lower unit". Accordingly, I don't think that use of a main home would constitute use of a personal second home, or that such use would ever be attributable to second home.

This is undeniably the rule under the 121 regs...part of the facts and circumstances test..."In the case of a taxpayer using more than one property as a residence" (quotes from the reg itself). And there's no question that the Harry's guy was using the residence (or at least part of it) as his primary residence. The issue we have is whether or not the ex's dwelling unit, which was not used at all by the taxpayer, in some way taints the taxpayer's overall "property" so as to bifurcate it into (1) a valid primary residence [which was used by the taxpayer] and (2) a separate dwelling unit (or separate residence) which is no longer considered part of the taxpayer's primary residence [because it was not used by the taxpayer].

If the bifurcation is not automatic, then taxpayer has a chance to explain himself and argue that the whole thing was his primary residence under the facts and circumstances. If this argument fails, or if the bifurcation is indeed automatic, then it seems the ex's dwelling unit would be viewed as not part of the taxpayer's primary residence.

but I think that this lends weight that the IRS is not looking at the lower unit as a second residence, since it is occupancy of the "upper portion" (main residence) that creates the "personal use of the lower unit"

The IRS tried to pull one over...and essentially argue that there were not 2 separate dwelling units. That is, the IRS' argument was predicated on trickery - trying to trick the judge into thinking that the property should be viewed as a single dwelling unit, and that the taxpayer was therefore renting "a portion" of the 1 dwelling unit, therby invoking 280A. Thus, IRS was trying to argue that the whole property was taxpayer's primary residence. Although this argument would be very helpful to us in Harry's situation, it's a faulty argument because the taxpayer in Gorod was actually renting a separate dwelling unit (as opposed to a portion of 1 dwelling unit), and this is why the judge didn't buy it.

So, I don't think we can take much away from Gorod. The facts are different. But I do want to see how the judge handled the expenses while the property sat vacant (assuming it wasn't held out for rent during this vacant timeframe).

qualified residence interest is deductible under section 163(a). Qualified residence interest is not subject to limitation or otherwise taken into account under section 163(d)"

"Qualified residence interest basically means interest paid or accrued during the taxable year on debt secured by either (1) the taxpayer's principal residence,"

Where is any requirement limiting the deduction, under the facts as stated? I can find none.

The interest is

Roy - Did my processor just reach its limits, or did you fall asleep at the keyboard?

This discussion was supposed to find an answer *millions* of bits ago; what happened?

Trillium - Are we *really* nearing the limit of some something? I'll go back and erase all the posts that irritate me, if that would help.

Refrigpbrerator. I know it's only Wednesday and it's not even four o'clock yet, but it's cloudy and the Redskins won last weekend...

The tax issues I see off the top: All the residence/dwelling unit/interest deductibility issues discussed in this thread above. Effects of the deed being in a family LLC. Business deductions possibilities for his concrete company, e.g., reimbursing Huff for the costs involved that may be 162 expenses.

All hypothetical, of course, but as one can see from some of my posts, I like hypotheticals. Since he is not my client, it matters not whether I have the facts and issues right, or whether I get answers. But I will again bate my breath.

I would have the company write into the employment contract of the president that he is required to live in the house as a condition of his employment so that he can demonstrate the features of the house to prospective customers, suppliers, media, etc.; thereby he providing him with a tax-free residence.

Not a bad deal, living rent-free while receiving lease income from the land and winding up with the house to boot.

There are probably some self-dealing statutes to work out, but I think it's doable.

Wow, can somebody disagree with my comments?

Actually, I must commend the great editor we have for comments.

I've tried to have a client pay - one way or another - for everything I've learned over my professional career. Often, I try to have *many* clients pay for my learning, over and over and over. That's called a professional money-making practice where I come from.

"Bill for value."

When doctors or lawyers do it, I think it stinks.

Don't you agree?