Tax Research Project 2
Introduction:
In 1976, Congress amended the tax law to include Section 280A (Lawyer, 1985) in the Internal Revenue Code. Congress’ reason for the amendment was due to concerns that people were renting out their vacation homes so that they could deduct personal expenses that would not, under normal circumstances, be deductible (Lawyer, 1985). Section 280A required vacation home owners to assign expenses connected with the vacation home either to personal use or rental use. Congress apparently hoped that Section 280A would limit or control the business deductibles for expenses sustained on a vacation home during the tax year when the home was used for both personal and rental purposes (Lawyer, 1985). In essence, what Section 280A did was eliminate business deductions on rental units that were also occupied by owners for personal use. But, Section 280A did offer a number of exceptions. The exception under 280A(c) (3), in particular, was the cause for much controversy. Under 280A(c) (3), deductions were allowed for any item attributable to the rental unit, such as maintenance fees, but any deduction had to first be computed according to Section 280A(e) and Section 280A(c) (5). Section 280A(e) stated that maintenance fees attributable to rental use would be determined by dividing the number of days the house was rented by the number of days it was used multiplied by the total amount of interest and taxes. 280A(c) (5) also allowed deductions for expenses attributed to the rental use of the home including maintenance fees. It also allowed deductions attributed to whether the house was rented out or not including taxes and interest but, unlike Section 280A (e), it did not provide a formula in which to determine the amount of any deduction applicable under its authority.
Facts:
In 1976, Dorance and Helen Bolton rented out the vacation house they owned located in Palm Springs, California. The house was occupied for a total of 121 days during that year. The Bolton’s lived in the house themselves for 30 days and rented it out for 91 days. For the remaining 244 days on 1976, the house was empty and unoccupied. For the year, the Bolton’s received $2700 in rental income; while incurring the following expenses: $2854 for mortgage interest; $621on property taxes; and $2693 in maintenance fees for the house. In completing their taxes for the year, the Boltons applied the following formula to determine the amount of deductions: the number of days rented out divided by the number of days in the year multiplied by the total interest and taxes. The United States Tax Court agreed with the Bolton’s choice and calculation. According to the Tax Court, there is a fundamental difference between maintenance fees and taxes or interest. Under the Tax Court’s analysis, maintenance fees are directly linked to the use of the house. The less it is used (rented out) the lower the fees accrued in maintaining it. Taxes and interest, however, accrue on a regular basis regardless of whether the house is rented or empty. Accordingly, the Tax Court that the difference between maintenance, interest and taxes required a different treatment as expressed in the Bolton’s formula. Any other formulation, the Tax Court argued, is unreasonable.
The Internal Revenue Service (IRS), on the other hand, disagreed with the Bolton’s and Tax Court’s interpretation of the law. According to the IRS, the correct formula for the determination of deductions under Section 280A(c) (5) should be based on the formula in Section 280A(e), namely dividing the number of days the house was rented out by the number of day the house was actually occupied multiplied by the total amount of taxes and interest.
Issue:
Should the Court defer to IRS’s interpretation of Section 280A or affirm the Tax Court’s ruling that the IRS’s position is unreasonable?
Analysis:
The Court held that the tax court’s (and by implication the Bolton’s) formula was indeed correct and the IRS’s interpretation of the law is unreasonable. In affirming the tax court’s ruling, the Court first determine just how much deference it should afford the IRS. The Court based its determination of the 1982 case, U.S. v. Vogel Fertilizer Company. Vogel also concerned a difference of opinion between a taxpayer and the IRS over the interpretation of a tax regulation. In affirming the for taxpayer, the Supreme Court sound that when considering the reasonableness of the IRS’s interpretation of a statute, tax courts should look to the statutory language, legislative history and whether the IRS or the tax court’s interpretation was more in harmony with the language and structure of the statute.
In the Bolton case, the Court first found that the IRS’s drafting of Section 280A was made under its general authority rather than a specific grant of authority to create the rule. Consequently, the court’s deference was required to be at its highest level. Second, the Court analyzed that statutory language, history and which interpretative harmonized better with the language of the law. According to the Court, while the language and legislative history provide no answers to which interpretation was correct, “the only clear point” was that IRS’ position did not correspond well with the language and structure of the statute. On the other hand, the Court did find that the tax court’s interpretation was reasonable and consistent with the legislative purpose of separating personal and business expenses of rental homes “by determining the maintenance which tends to vary with occupancy rate is allocated in accordance with occupancy.”
Facts:
Although the Ninth Circuit rules against the IRS in the Bolton case, the agency continued to argue that its interpretation of Section 280A was indeed correct (Lawyer, 1985). A little less than a year after the Bolton ruling, the IRS was afforded another opportunity to make its case in Mckinney v. Commissioner out of the Tenth Circuit. The facts of McKinney were similar to those in Bolton. The McKinney’s owned a home in Hawaii which they rented out 85 days of the year and occupied themselves for 20 days of the year. For the remaining 260 days, the home was unoccupied. Like the Boltons, in preparing their taxes, the McKinneys used the same formula for deduction that the tax court used in Bolton. The IRS, again, disagreed and argued that the correct formula was the same as explained in Section 290A (e).
Issue:
Is the tax court’s formula for determining deductions under Section 280(c) (5) correct?
Analysis
Relying heavily on the Ninth Circuit’s ruling in Bolton, the Court again affirmed the tax court’s interpretation of the statute. Indeed, the Court completely agreed with the analysis and conclusions of the Ninth Circuit ruling. The Tenth Circuit’s ruling however, particular emphasized the difference between maintenance fee which necessarily rise according to occupancy and taxes and interest which rise regardless of occupancy.
Conclusion and Recommendation
Thus, applying the Courts’ rulings in Bolton and McKinney to the case of our client’s Calvin and Lorna, the formula that should be used in the allocation of interest and taxes to rental use should be dividing the number of days the Ozark Mountain property was rented out by 365 (the number or days in the year) and multiplying that amount by total interest and taxes. The calculations are demonstrated as follows:
Gross rental income $8500
Total interest and property taxes $9300
Allocation fraction 75/365 = 21% $1953 (attributable to rental use)
Rental income in excess of interest and property taxes $6547
Total maintenance expenses $400
Allocation fraction 75/100 = 75%
Maximum allowable deduction for maintenance $300
The deductible amount is $6547; including $300 that can be deducted from maintenance expenses. Accordingly, I would recommend that Calvin and Lorna follow this method of calculating their taxes.
Works Cited
Bolton v. Commissioner, 694 F.2d 556 (1982). Retrieved on October 14, 2014, from https://openjurist.org/694/f2d/556/bolton-v-comissioner-of-internal-revenue
Lawyer, J.T. (1985). Vacation homes, Section 280A and Bolton v. Commissioner: The right result for the wrong reasons. Retrieved on October 14, 2014, from https://scholarship.law.duke.edu/cgi/viewcontent.cgi?article=2921&context=dlj
McKinney v. Commissioner, 732 F.2d 414 (1983). Retrieved on October 14, 2014, from https://www/casetext.com/case/mckinney-v-cir
United States v. Vogel Fertilizer Co., 455 U.S. 16 (1982). Retrieved on October 14, 2014, from http://caselaw.lp.findlaw.com/scripts/getcase.pl?court=US&vol=455&invol=16
