The U.S. Tax Court ruled Monday that a rental home that sits vacant for an extended period can still be considered a rental property.
The case involved a taxpayer who had moved from Kansas City to Minneapolis in 1988. The taxpayer rented out their old home in K.C. until 2005. The home then sat vacant in 2006 and 2007 but the taxpayer continued to take rental expense deductions. The IRS audited the returns and disallowed the rental losses on the grounds that the taxpayer lacked profit motive.
The Court sided with the taxpayer. The key factor for the Court seemed to be that the home’s value had increased since 1988. From the Court ruling (my emphasis added):
In the case of an individual, section 212 allows as a deduction all ordinary and necessary expenses paid or incurred during the taxable year for the production or collection of income or for the management, conservation, or maintenance of property held for the production of income …. For purposes of this section, the term “income” includes not only income of the current year but also income that may be realized in a subsequent year.
So because the home was worth more in 2006 and 2007 than it was in 1988, the Court said there was still a profit motive even though the home was vacant in those years. The Court cautioned that if the home’s value dropped in future years, then the profit motive might come into question again:
It may be that an abandonment by petitioner of any meaningful attempt to rent the Kansas City house, coupled with the collapse of the real estate market, might negate a finding for some future year that the property was held for production of income. But for 2006 and 2007 the record supports such a finding….
It wasn’t all happy news for the taxpayer, though. The Court ruled that she couldn’t substantiate all of her claimed deductions, so instead of being able to claim losses in excess of $12,000 each year, her allowable losses were reduced to the $6,000 range and she was also hit with penalties.
Joe Kristan at the Tax Update Blog tackles the story from a different angle, talking about why many of the taxpayer’s deductions were disallowed due to lack of substantiation: Rental House Deduction Disaster.