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Sunday, December 3, 2023

Odd Exclusion for Home Rental Is Overdue for Repeal

home with red bow tied around it

IRC Section 280A was enacted in 1976 (P.L. 94-455). This provision deals with office in the home and rental of a residence. It has a few provisions that either are no longer needed (rental of a residence can be governed by the passive activity loss limitation added in 1986) or clarified (the home office rules are not easy to get through). And ... subsection (g) should be repealed as inequitable and unnecessary.

Section 280A(g) provides that if a "dwelling unit" is used as a residence and rented for less than 15 days during the year, the rental revenue is tax-free! 

There is no logic to this exclusion. Anything else rented for 14 days or less during the year doesn't produce tax-free income. Perhaps it was to address small amounts of income someone might generate such as when a movie studio uses all or part of a home for 14 days or less. This rule is referred to by some as the "US Open tax break" because if your home (main home or vacation home) is near a venue where a major event will take place such as the US Open, the Super Bowl, a political convention, or other event where someone would love to rent your home, you are the winner. You can charge a lot of revenue and it's tax free. If you incur extra insurance or cleaning expenses, they are not deductible, but this is still a significant tax break.

In a recent case, Sinopoli, TC Memo 2023-105, the IRS and Tax Court allowed its use where shareholders of an S corporation held monthly meetings in each shareholders' homes resulting in each renting their "dwelling unit" for under 15 days. Now, they were charging way beyond what fair rent was (they charged $3,000 per use) but the IRS and court agreed on $500 although the court found this IRS figure to be "generous." 

The tax benefit to these shareholders is that they get to reduce their S corp income by this rental expense the corporation incurred and they get to treat the rent paid to them as tax-free. 

Oddities of this exclusion:

  • There was no information in Senate Report 94-1192 for P.L. 94-455 as to why the exclusion was included in a provision intended to clarify the rules for when someone could claim a deduction for an office in their home.
  • In the Sinopoli case, why should a deduction result in no income to the other party who provided the property? The Tax Court referred to the shareholder and S corp plan as a "tax savings scheme to distribute" the S corp's earnings to shareholders tax free. Why does our tax system have such a scheme?
  • When a business rents property from someone and pays $600 or more, they are required to issue a From 1099-MISC to the lessor making it easy to track and report as income (Section 6041).
  • When the lessee is not a business, the lessor can still identify that they collected rental income. After all, that lessor figured out how to advertise their home for rent, they can make a note in their tax files to pick up the rental income.
  • It has been known for years that this exclusion is used by people of means collecting significant rentals, such as during the US Open or Super Bowl, tax free. This is exclusion is not based on fairness, ability to pay, or any need to encourage such tax-free activity.
I'm not aware of any reason to justify keeping this exclusion. What do you think?


Robert W. Jamison said...

Well stated, Annette. The decision is absurd, but completely within the law. Unfortunately, it also seems to be within the intent of the law.

Kip Dellinger said...

I believe the exclusion extends even to a sub rental as long as it’s a dwelling unit

Anonymous said...

I agree. It should be repealed. Too many tax preparers “discover” this opportunity to place their clients at risk. And it is inequitable.