Q&A with the Pennsylvania Department of Revenue

Scenario: not-for-profit rental activities

Sep 25, 2014

Scenario:

Ted and CJ are great friends. Ted agrees to rent the apartment above his garage to CJ for the next five years. Because CJ has difficulty with the budgeting of his money, and is trying to get back on his feet, Ted agrees to rent the apartment to CJ at a reduced rate. In Year 1 of this arrangement, Ted realizes that he will – and in fact does – incur losses on the rental activity for at least the next four or five years. In Year 1 of this arrangement, Ted decides to go ahead with treating the rental activity as a hobby/not for profit loss for the federal income tax purposes because he never intends to make a profit. The federal rules limit deductions in not for profit rental activities and Ted’s rental expenses, primarily depreciation, were limited on his federal income tax return to the extent of the rental income. For Federal income tax purposes, rental expenses must be treated as miscellaneous itemized deductions in not for profit rental activities. Because Ted’s itemized deductions were limited, Ted experienced taxable income as result of this rental activity. On Ted’s PA personal income tax return, he deducts 100% of the rental expenses against his rental income and reflects the entire loss on his return.

Q:

Is this correct, or are Ted’s expenses somehow limited, due to the hobby / not-for-profit activity?

A:

Ted’s expenses are also limited for PA PIT purposes since he does not intend to realize a profit. His expenses directly incurred for the property are limited to the amount of rental income claimed. In addition, he may not claim depreciation expense for the property.

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These documents provide a summary of the answers provided by the Department of Revenue to the PICPA Committee on State Taxation at its annual question and answer session. These documents are classified as revenue information issued for informational purposes only for the convenience of PICPA members. Pursuant to 61 Pa. Code Section 3.4, these documents should not be relied upon for any purpose or used in tax appeals. Taxpayers requiring a binding opinion on their specific fact situation may request a written letter ruling under 61 Pa. Code Section 3.3.