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For years the IRS and taxpayers have contested the proper allocation of interest and taxes
expenses related to a second (vacation) home. The IRS has insisted that the denominator used to
allocate rental vs. personal days should be the total days the property was actually occupied
(used) during the year, while taxpayers have followed the decision in Bolton, 694 F2d 556
(1982) allowing the use of 365 days as the denominator. Although the arguments have focused
on situations where the rental expenses are limited to rental income under Code Sec. 280A (i.e.,
personal usage days exceed the greater of 14 days or 10% of the days rented), there are also
implications when the Code Sec. 280A limitations are not violated. Specifically, if the property
is classified as a ?rental property,? then interest expense for personal usage days is not deductible
because the property cannot be both a rental and a personal residence at the same time. This
brings up the question of whether a property owner might be better off to violate the usage limits
deliberately so that the personal interest would be deductible (i.e., the vacation home is classified
as a second residence).
Your client, Milli Vanilli, has come to you in November with some questions regarding a
vacation rental and you have tasked your intern to develop a spreadsheet for some of the
monetary information to help aid in you decision
The spreadsheet assumes that, near the end of the year, the vacation home owner has rented the
property for 260 days and has used the property for personal reasons a total of 26 days. Thus,
one more personal day will invoke the Sec. 280A vacation home limitations however; such a
scenario will permit the taxpayer to deduct the allocated personal interest as well.
Using the spreadsheet, answer the following questions put forth by your client. Please be sure to address
these answers in your research memo to the file as well as in your client letter.
1 The saved version of the spreadsheet currently assumes that the total annual interest expense related to
the property is $6,875. Based on this assumption, should your client use the property one additional day
for personal reasons?
2. Examine the allocated interest and taxes closely in the ?Current Result? columns of the spreadsheet.
Notice that even though the Bolton method is used for both interest and taxes, the same fraction does not
apply to the two expenditures. Explain this apparent inconsistency. You may want to refer to the
discussion of vacation rental homes in Chapter 11 of the text.
The interest expense may go up next year as his ARM is set to begin to adjust. Assuming the interest was
to increase next year, what are some planning considerations that Mr. Vanilli should consider when he is
determining the number of personal versus rental days next year? (Please note, I do not want concrete
calculations, instead I want some general advice regarding deductions, carryovers etc. with support.)
This question was answered on: Sep 18, 2020
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