Industry Insights

In a recent Internal Legal Memorandum (ILM), the IRS concluded buildings used to provide housing to nursing care and assisted living residents are properly classified as residential rental property—good news for owners and operators of nursing care, assisted living and retirement facilities.

Classifying and depreciating buildings as residential rental property can be highly advantageous from an income tax perspective, as residential rentals are depreciated over 27.5 years, compared to 39 years for nonresidential buildings. In the case of a building costing $5 million, a 27.5-year life would accelerate a taxpayer’s deduction for depreciation by about $53,600 per year.

Buildings or other structures are residential rental property if 80 percent or more of the gross rental income generated from the building is income from “dwelling units,” defined as houses or apartments that provide living accommodations, where more than 50 percent of such units are not used on a transient basis. Therefore, hotels and motels generally do not qualify, due to their transient nature.

The 80 percent test is calculated as follows: 

Gross Rental Income from Dwelling Units / Gross Rental Income from the Building

The key provision for nursing and other long-term care facilities lies in the definition of gross rental income. Rental income includes only gross income attributable to, or ordinarily associated with, the use of a unit as a living accommodation. Therefore, gross income from providing significant services of the type not ordinarily provided in connection with the mere rental of rooms is not rental income. In other words, gross income from providing patient care and support services is excluded from both the numerator and the denominator in the fraction above, making it very easy to meet the 80 percent test. 

In a typical situation, a resident pays a monthly amount to a nursing facility and receives in exchange a place to live and some level of care assistance. Some allocable portion of this amount is received by the nursing facility for the right to use a dwelling unit and constitutes rental income for purposes of the 80 percent test. The allocation between rent and care services is not relevant, because the portion allocated to care services is excluded from the calculation entirely.

The ILM also concluded even though taxpayers may classify and report all of the income received from residents as income from care services, this subjective designation does not control whether the property is residential rental property for depreciation purposes. The IRS also concluded neither a formal lease nor a landlord-tenant relationship is required for property to be characterized as residential rental property.

Taxpayers currently using an incorrect depreciation method may be able to obtain automatic IRS consent to change methods by filing Form 3115, Application for Change in Accounting Method. Applications filed under the automatic change procedures do not require a user fee and may be filed as late as the extended due date of the income tax return. 

If you would like more information on the treatment of nursing and other retirement care facilities as residential rental property or you would like help requesting a change in accounting method, please contact your BKD advisor or .