Haunting Houses:
Taking the Mystery Out of Mixed-Use Real Estate Reporting
By Janet C Hagy, CPA-Austin
July 20, 2023
While most tax professionals are familiar with allocating mixed-use property expenses and depreciation between rental and personal use days, an often-overlooked rule applies to rental property with average tenant use of seven days or less per tenant contract period during any calendar year. A day of use is defined as an overnight stay. Average use calculation is defined as the total rental days divided by the number of rental contracts. The average is computed on an annual basis.
Personal use days include overnight stays by any owner or family member[1] whether or not fair market rent is paid; guests not paying fair market rent; reciprocal rental agreements;[2] and stays donated to charities for any use including auction or sale by the charity.[3]
Owners can exclude a day’s use as a personal day when the primary purpose for being there is to perform repairs or maintenance on the property.[4] All persons present on that day do not have to be working on the property.
In any case, if rented for fewer than 15 days during the entire year, income is not taxable and expenses other than mortgage interest and property taxes are not deductible. This can be a great source of tax-free income during special local events or as a filming location.
The number of rental days and personal use days, as well as the kind of services provided by the landlord, affect the reporting of rental activity. Significant personal services like providing breakfast or chauffeur may change the nature of the rental to hotel-like treatment.[5] A summary of the differences in reporting mixed-use rental activity for different scenarios follows:
A. Rental of residential property for an average use per tenant of more than seven days.
- With personal use days of 14 days or less
- Not considered a personal residence, so allocated personal mortgage interest is not deductible on Schedule A.
- Excess rental losses are carried forward.
- IRC Section 199A does not apply.[6]
- With personal use days greater than the larger of 14 days or 10% of the number of days rented at FMV
B. Rental of residential property for an average use per tenant of seven days or less and no significant services provided.
- Allocation of expenses for personal days uses the same rules as other mixed-use rentals.
- Reported on Schedule E.
- Not subject to self-employment tax.
- Not considered a real estate rental activity under IRC Section 469.[9]
- Does not qualify for the $25,000 real estate rental loss allowance.
- Losses are not limited to rental income for that property.
- Material participation rules apply in determining deductible losses.
- Real estate professional exception does not apply.
- Property cannot be grouped with other rental real estate.
- Excess losses carryover to future years until used against income or the property is sold.
- Section 199A may apply if there is no personal use. See Rev. Proc. 2019-38 for final rules related to 199A qualifying safe harbor rental property.
C. Rental of residential property when significant services are provided and the average use period is less than 30 days.
- Reported on Schedule C as a hotel-like facility.
- Losses are not limited to rental income.
- Subject to self-employment tax.
- Not considered a real estate rental activity under Section 469.ix
- Material participation rules apply in determining deductible losses.
- Section 199A applies if there are no personal use days.
Obtaining from the client all the details of mixed-use property rental days, terms of each rental contract and the landlord services provided is essential for correct tax reporting.
FOOTNOTES
7 IRS Publication 527, Worksheet 5-1 https://www.irs.gov/publications/p527#en_US_2022_publink10003726
8The IRS Passive Activities Audit Technique Guide identifies a possible disallowance of all losses on personal use property under the temporary rental doctrine if there is no profit motive and less than 1-2 years rental history.