Depreciation and changes in use of real property.

AuthorPitt, Andrew J.

For income tax purposes, taxpayers that own rental property with gross receipts from residential or nonresidential uses should heed the rules on accounting for depreciation. This item discusses the distinction between residential and nonresidential property, depreciation, and the application of the change-in-use regulations if a rental property changes from residential use to nonresidential or vice versa.

Dwelling-Unit and Gross-Receipts Tests

Sec. 168(e)(2) defines residential rental property as any building or structure from which 80% or more of the gross rental income for the tax year is from dwelling units. Nonresidential real property is Sec. 1250 property that is not residential rental property or that does not have a class life of less than 27.5 years.

In determining whether a property meets the 80%-gross-receipts test to qualify as residential rental property, taxpayers may include in gross rental income the rental value of any portion of the building that they occupy. For hotels, motels, and other establishments, the 80%-gross-receipts test is disregarded if more than 50% of the dwelling units are used on a "transient basis."

For purposes of defining residential rental property, "dwelling unit" means a house or apartment used to provide living accommodations in a building or structure, but it does not include a unit in a hotel, motel, or other establishment in which more than 50% of the units are used on a transient basis. Former Regs. Secs. 1.167(k)-3(c)(1) and (2), which were removed in 1993, provided that a dwelling unit was used on a transient basis if, for more than one-half of the days in which the unit was occupied on a rental basis during the taxpayer's tax year, it was occupied by a tenant or series of tenants, each of whom occupied the unit for less than 30 days. If a dwelling unit was occupied subject to a sublease, the taxpayer looked to the sublessee to determine whether the dwelling unit was used on a transient basis.

The definition of dwelling units indicates that, under the right circumstances, properties such as nursing homes, retirement homes, and college dormitories can qualify as residential rental property as long as they do not run afoul of the transient-basis requirement. This assumes the 1993 definition of "transient basis" still applies, as the term still appears in Sec. 168(e)(2)(A)(ii)(I), which defines "dwelling unit. "In CCM 201147025, the Office of Chief Counsel cited Regs. Secs. 1.167(k)-3(c)(1) and...

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