Home Office Qualifies as Residential Rental Property

A owns an apartment building with eight essentially identical units. He lives in one apartment and leases the other seven to tenants as dwelling units. A’s apartment is 1,200 square feet; he uses 200 square feet exclusively for a home office for a single trade or business, which may or may not be the rental of residential property. A otherwise satisfies Sec. 280A’s requirements for taking home office deductions, including depreciation.

Law and Analysis

Sec. 168(c) provides that for purposes of the Sec. 168 general depreciation system, the applicable recovery period for residential rental property is 27.5 years; for nonresidential property, it is 39 years. Under Sec. 168(e)(2)(A)(i), “residential rental property” is any building or structure if 80% or more of its gross rental income is derived from dwelling units. Under Sec. 168(e)(2)(A)(ii)(II), if a taxpayer occupies any portion of the building or structure, the gross rental income includes that portion’s rental value.

According to Regs. Sec. 1.167(j)-3(b)(3), the gross rental income from a building is gross rental income from a dwelling unit only if the rental income is attributable to, or ordinarily associated with, using the unit as a living accommodation. If a portion of the building is used for a drugstore, grocery store, commercial laundry or other commercial operation, for example, the rent paid for such portion (including any amount paid for services in connection with the operation) is not rental income from a dwelling unit. Similarly, if pursuant to a lease or other agreement, a portion of a house or apartment is used as office space (e.g., as a doctor’s office), the rent paid thereon is gross rental income from the building, not rental income from a dwelling unit.

Sec. 168(e)(2) defines property as residential rental property by reference to a “building or structure,” not to a dwelling unit or portion thereof. For a building to be residential rental property, it must contain at least one dwelling unit actually rented to provide living accommodations. If the building satisfies this threshold test, the 80%-of-gross-rental-income test would apply.

Conclusion

A’s home office space meets the residential rental property test and qualifies for 27.5-year depreciation, even if he uses his home office space for a business other than residential property rental. Of the eight units in A’s building, seven are leased as dwelling units; A occupies one unit.

A portion of A’s unit is exclusively used as a home office (200 square feet); the remainder is used as a personal residence (1,000 square feet). Even though the rental value of the 200 square feet the taxpayer uses for a home office is not treated as rental income from a dwelling unit, the entire building satisfies the “80%” test for treating it as residential rental property. Sec. 280A does not require a taxpayer to carve out a “nonresidential real property” portion from a building that is residential rental property under Sec. 168(e)(2). Thus, A should calculate depreciation based on treating the unit as residential rental property, and using a 27.5-year recovery period (or a 40-year recovery period, if the Sec. 168(g) alternative depreciation system applies).

Chief Counsel Advice 200526002 (7/1/05)