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may be used by such taxpayer, free of the passive activity limitations, is then lowered by $1 for every
$2 of additional income, disappearing entirely at $150,000. Given his success in business, the
usefulness of rental losses in the absence of passive income seems problematic to Morris, at best.
Another tax rule appears to Morris to limit the usefulness of losses even further. Under the Internal
Revenue Code, a parcel of real estate falls into one of three categories: personal use, rental use, or
mixed use. A personal use property is one that is rented 14 days or less in a year and otherwise used
by the taxpayer and family. No expenses are deductible for such a facility except taxes and mortgage
interest. A rental use property is used by the taxpayer and family for less than 15 days (or 10% of the
number of rental days) and otherwise offered for rental. All the expenses of such an activity are
deductible, subject to the passive loss limitations. A mixed use facility is one that falls within neither
of the other two categories.
If Morris were to engage in a serious rental effort of his property, his occasional weekend use,
combined with his two-week stay around the golf tournament, would surely result in his home falling
into the mixed use category. This would negatively impact him in two ways. The expenses that are
deductible only for a rental facility (such as maintenance and depreciation) would be deductible only
on a pro rata basis for the total number of rental days. Worse yet, the expenses of the rental business
would be deductible only to the extent of the income, not beyond. Expenses that would be deductible
anyway (taxes and mortgage interest) are counted first in this calculation, and only then are the
remaining expenses allowed. The result of all this is that it would be impossible for Morris to generate
a deductible loss, even if it were possible to use such a loss in the face of the passive loss limitations.
Naturally, therefore, Morris has long since decided not to bother with attempting to rent his country
getaway when he and his wife are unable to use it. However, the scheduling of the closing this year
presents a unique tax opportunity of which he may be unaware. In a rare stroke of fairness, the Internal
Revenue Code, while denying any deduction of not otherwise deductible expenses in connection with
a home rented for 14 days or less, reciprocates by allowing taxpayers to exclude any rental income
should they take advantage of the 14-day rental window. Normally, such an opportunity is of limited
utility, but with the tournament coming to town and the hotels full, Morris is in a position to make a
killing by renting his home to a golfer or spectator during this time at inflated rental rates. All that
rental income would be entirely tax-free. Just be sure the tenants don‟t stay beyond two weeks.
Like-Kind Exchanges
Having acquired the desired new business and secured the services of the individual he needs to run it,
Morris turns his attention to consolidating his two operations so that they might function more
efficiently. After some time, he realizes that the factory building acquired with the plastics business is
not contributing to increased efficiency because of its age and, more important, because of its distance
from Morris‟s home office. Morris finds a more modern facility near his main location that can
accommodate both operations and allow him to eliminate some amount of duplicative management.
Naturally, Morris puts the molding facility on the market and plans to purchase the new facility
with the proceeds of the old one plus some additional capital. Such a strategy will result in a tax upon
the sale of the older facility, equal to the difference between the sale price and Plant Supply‟s basis in
the building. If Morris purchased the molding company by merging or purchasing its assets for cash,