336 Planning and Forecasting
effective executive compensation package. In fact, the only real disappoint-
ment for Morris was that the closing of the deal was scheduled to take place
during the week in which he normally took his annual vacation.
Some years ago, Morris had purchased a country home for use by himself
and his wife as a weekend getaway and vacation spot. With the press of busi-
ness, however, Morris and his wife had been able to use the home only on oc-
casional weekends and for his two-week summer vacation each year. Morris
always took the same two weeks for his vacation so he could indulge his love of
golf. Each year, during those two weeks, the professional golfers would come to
town for their annual tournament. Hotels were always booked far in advance,
and Morris felt lucky to be able to walk from his home to the first tee and enjoy
his favorite sport played by some of the world’s best.
Some of Morris’s friends had suggested that Morris rent his place during
the weeks that he and his wife didn’t use it. Even if such rentals would not
generate much cash during these off-season periods, it might allow Morris to
deduct some of the expenses of keeping the home, such as real estate taxes,
mortgage payments, maintenance, and depreciation. Morris could see the ben-
efit in that, since the latter two expenses were deductible only in a business
context. Although taxes and mortgage interest were deductible as personal ex-
penses (assuming, in the case of mortgage interest, that Morris was deducting
such payments only with respect to this and his principal residence and no
other home), the previously mentioned limits on the use of itemized deduc-
tions made the usefulness of these deductions questionable.
However, in addition to the inconvenience of renting one’s vacation home,
Morris had discovered a few unfortunate tax rules which had dissuaded him
from following his friends’ advice. First, the rental of a home is treated by the
Code in a fashion similar to the conduct of a business. Thus, Morris would gen-
erate deductions only to the extent that his expenses exceeded his rental in-
come. In addition, to the extent he could generate such a loss, the rental of real
estate is deemed to be a passive activity under the Code, regardless of how
much effort one puts into the process. Thus, in the absence of any relief provi-
sion, these losses would be deductible only against other passive income and
would not be usable against salary, bonus, or investment income.
Such a relief provision does exist, however, for rental activities in which
the taxpayer is “actively” involved. In such a case, the taxpayer may deduct up
to $25,000 of losses against active or portfolio income, unless his total income
(before any such deduction) exceeds $100,000. The amount of loss which may
be used by such taxpayer, free of the passive activity limitations, is then low-
ered 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, seemed problematic to Morris, at best.
Another tax rule appeared to Morris to limit the usefulness of losses even
further. Under the Code, a parcel of real estate falls into one of three cate-
gories: personal use, rental use, or mixed use. A personal use property is one
which is rented 14 days or less in a year and other wise used by the taxpayer and