Owner Lacked Profit Motive in House Rental

Stephanya inherited a rundown house from her grandmother. A real estate agent told her it would sell quickly for $229,000. But it needed repairs.

Instead of selling, Stephanya decided to rent the house to her brother, Ronny, in exchange for $500 a month rent and his promise to repair the house. In May 1992, Ronny moved into the house with his girlfriend and their child. But that December they decided to move out.

In January 1993, Stephanya listed the vacant house for sale with a Realtor at $230,000. But it didn’t sell. In March, she listed it with another Realtor at $219,000. It finally sold in July 1993 for $180,000.

On her 1993 income tax returns, Stephanya deducted a $5,852 rental loss and an ordinary loss of $73,501 on the sale of the house.

Upon audit, the IRS denied the $5,852 rental loss for 1993 because there was no rental income and the $73,501 sale loss because there was no profit motive in renting the house at a below-market rent to Stephanya’s brother. She took her case to the U.S. Tax Court.

If you were the U.S. Tax Court judge, would you allow Stephanya to deduct her $5,852 rental loss and $73,501 sale loss?

The judge said no.

As for the rental loss, the judge explained, there is no evidence Stephanya collected any rent from her brother in 1993. Therefore, she cannot deduct a $5,852 rental loss on a vacant house that was listed for sale rather than rental in early 1993.

Internal Revenue Code 165 allows deduction of losses incurred in a “trade or business” and “any transaction entered into for profit,” the judge said.

But the below-market rental to Ronny indicates Stephanya did not have a profit motive for renting this house, nor did she hold the house for production of income, he noted.

Therefore, Stephanya did not have a profit motive for owning the house and she cannot deduct her loss upon the sale, the judge ruled.

Based on the 1998 U.S. Tax Court decision in Ronald P. and Stephanya M. Barranti, T.C. Memo 1998-427.