Category: Deductions & Credits; Individuals Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com Background Issues 2. Do depreciation deductions not allowed by reason of Section 280A(c)(5) reduce basis? 3. How are the sales proceeds from disposition allocated between rental and personal use? Answers 2. Depreciation deductions not allowed by reason of Section 280A(c)(5) do not reduce basis. 3. It is not clear how sale proceeds, basis, expenses of sale, etc. should be allocated in the year of sale between business and personal use. Discussion "...the deductions allowed under this chapter for the taxable year by reason of being attributed to such use [in this case rental use] shall not exceed the excess of the gross income derived from such use for the taxable year, over..." [Bracketed commentary added.] The issue of whether gross income for this purpose includes disposition income is not directly addressed. I think the words of the statute are fairly clear: the only gross income that counts for this purpose is income from rental use. I feel that income from disposition of rental property is not the same as income from rental use. In the absence of any guidance on this point, the statute should be interpreted based on the plain meaning of its words. I think equating disposition with rental use would be an extremely strained interpretation of these words, and I doubt very much that such an interpretation would be supportable if challenged. Adjusted basis takes into account depreciation allowed or allowable. Clearly, depreciation amounts not allowed due to Section 280A(c)(5) are not allowed, but are these amounts allowable? Proposed Regulation Section 1.280A-3(d)(iii) addresses this issue as follows. The allocable portion of amounts allowable as deductions for the taxable year under chapter 1 of the Code by reason of rental use of the dwelling which would result in an adjustment to the basis of property are allowable to the extent the gross rental income exceeds the deductions allowed under subdivision (i) and (ii) of this subparagraph. By virtue of this proposed regulation, depreciation amounts are not considered allowable unless there is sufficient gross income from the activity to permit such depreciation amounts to be claimed after consideration of the 280A(c)(5) limitation. The final issue is how to split sales proceeds, basis, expenses of sale, etc. as between business and personal. This issue does not seem to be addressed. You have suggested comparing on a historical basis rental days versus personal days. That is certainly a reasonable approach in my view. On the other hand, there is case for considering only the business percentage in the year of sale. Rev. Rul. 82-26, 1982-1 CB 114, describes a taxpayer who used a portion of his home as an office for five full years. After a law change, the taxpayer was no longer able to deduct office-in-the-home expenses even though he continued to use that same portion of his home for business purposes for an additional six years prior to selling the residence. The ruling held the taxpayer was not required to bifurcate the sale into personal and business portions, although depreciation claimed reduced the taxpayer's basis for purposes of the sale. The ruling does not specify the reasoning behind ignoring prior business use. While the context of this ruling is whether (not how) an allocation should be made, it does support the argument that the business usage at the time of sale determines whether--and if so, presumably how-an allocation should be made between business and personal. I suggest doing the computation both ways, choosing the best result, and putting the client on notice that there is a risk of this item being successfully challenged in the event of audit. |
