Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 75-14

1975-1 C.B. 90

Section 62 -- Adjusted Gross Income
Section 162 -- Business Expense Deduction
Section 183 -- Not-for-Profit Activities
Section 212 -- Expense of Producing Income

IRS Headnote

House rented to relative at less than fair market value; deductibility of expenses. A taxpayer who rents a house to his brother for less than the fair market value and less than his total expenses attributable to the house may not deduct, under sections 162 and 212 of the Code, the interest, taxes, operating expenses, and depreciation but he may deduct the expenses to the extent allowed under section 1.183-1(b)(1) of the regulations provided he itemizes his deductions.

Full Text

Rev. Rul. 75-14

Advice has been requested whether expenses incurred by an individual taxpayer in connection with property rented at less than fair rental value are allowable as deductions, under the circumstances described below, and whether the expenses if allowable are deductible from gross income in computing adjusted gross income or are deductible from adjusted gross income in computing taxable income.

During 1973 an individual rented a house that he owned to his brother and sister-in-law at less than its fair rental value. The expenses attributable to the house consisted of interest, taxes, operating expenses, and depreciation. The total of these expenses exceeded the gross income from the property.

Section 183 of the Internal Revenue Code of 1954 is the exclusive provision for allowing as deductions any expenses attributable to activities not engaged in for profit for taxable years ending after December 31, 1969. Section 183(c) defines the term "activity not engaged in for profit" as any activity for which deductions are not allowable under section 162 or 212(1) or (2). A profit motive must be present for deductions to be allowable under section 162 or 212. See Hirsh v. Commissioner, 315 F. 2d 731 (9th Cir. 1963); Carkhuff v. Commissioner, 425 F. 2d 1400 (6th Cir. 1970). Since the taxpayer rented out the house at less than fair rental value and the expenses attributable to the rental of the house exceeded the gross income derived from the house, the required profit motive was not present and the taxpayer was neither engaged in a trade or business under section 162 nor holding property for the production of income under section 212. Therefore, deductions are not allowable under those sections and section 183 applies.

Section 1.183-1(b)(1) of the Income Tax Regulations provides, generally, that if an activity is not engaged in for profit, deductions are allowable under section 183(b) of the Code in the following order and only to the following extent: (1) amounts allowable as deductions during the taxable year without regard to whether the activity was engaged in for profit are allowable in full; (2) amounts that would otherwise be allowable if the activity were engaged in for profit that would not result in an adjustment to the basis of the property if allowed are allowed only to the extent the gross income derived from the activity exceeds the deductions allowed or allowable in (1); and (3) amounts that would otherwise be allowable if the activity were engaged in for profit that would result in an adjustment to the basis of the property if allowed are allowed only to the extent the gross income derived from the activity exceeds the deductions allowed or allowable in (1) and (2).

Accordingly, (A) interest and taxes are deductible in full because they would otherwise be allowable under sections 163 and 164 of the Code; (B) operating expenses are deductible to the extent that the gross income from the rental of the house exceeds the interest and taxes; and (C) depreciation is deductible to the extent that the gross income from the rental of the house exceeds the interest, taxes, and operating expenses.

Section 62 of the Code sets forth those deductions to be subtracted from gross income in computing adjusted gross income in the case of an individual. In general, under section 62(1) the deductions allowed by chapter 1 of the Code that are attributable to a trade or business carried on by the taxpayer, except as an employee, are subtracted from gross income in computing adjusted gross income. Under section 62(5) the deductions allowed by part VI of the Code (of which section 183 is a part) that are attributable to property held for the production of rents are subtracted from gross income in computing adjusted gross income.

However, since deductions allowed under section 183 of the Code cannot be attributable to a trade or business, section 62(1) does not apply. Property is only held for the production of rents when the primary purpose in holding the property is to produce rental income in excess of the expenses attributable to the property. In other words, there must be a profit motive. Thus, if an activity is not engaged in for profit under section 183(c), then the property associated with such activity is not held for the production of rents within the meaning of section 62(5).

Accordingly, any deductions allowable under section 183 of the Code are to be deducted from adjusted gross income in computing taxable income. These deductions may be taken only if the taxpayer itemizes his deductions. They may not be taken if the taxpayer elects to use the optional tax tables or the standard deduction. Therefore, the taxpayer in the present case may deduct those expenses allowable as deductions under section 183 for interest, taxes, operating expenses, and depreciation only if he itemizes his deductions.