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Deductions for use of residence by day care providers.

Under Section 280A(c)(4), taxpayers engaged in the business of providing day care services are allowed certain -- often substantial -- deductions attributable to the use of their home in the activity. In Rev. Rul. 92-3, the Service has recently given additional guidance regarding the proper allocation and deduction of such costs.(1) Although the deduction requirements have been simplified, many unresolved questions remain. This article discusses the general requirements for taking the deduction and the impact of the ruling on the day-to-day operation of day care operators, including planning opportunities to take full advantage of the Service's stated position.

What Services Qualify?

Day care services are services provided to children, persons age 65 or over, or persons physically or mentally incapable of caring for themselves.(2) Such services must be primarily custodial in nature and provided for only certain hours of the day. Foster care and similar continuous live-in arrangements, as well as services which are primarily educational in nature, do not qualify as day care services. However, the fact that children or other recipients are also involved in educational, developmental or enrichment activities does not disqualify the operation, so long as such activities are incidental to the custodial services.(3) Although the term "children" is not defined in the code or regulations, it seems reasonable to classify any individual under the legal age of majority in such category. Thus, day care services under the statute could include not only pre-school age children, but also school age children where the child is cared for before or after school hours.

Qualified day care services must comport with any applicable state law requirements. Unless exempted, the service provider must have applied for or actually hold the appropriate state and/or local license, certification, registration or approval to operate as a day care provider.(4)

Deduction Limitations

Deductions attributable to the use of the home in providing day care services are available only where a portion of the home is used on a regular basis in such activity. Whether the residence is used on a regular basis for day care services is to be determined in light of all the facts and circumstances.(5) The deductions may not exceed the gross income derived from the activity less the sum of:

1. deductible operating expenses of the activity other than those attributable to use of the home (i.e., the cost of food, diapers, supplies, etc.), and

2. costs allocable to the activity which the taxpayer would have deducted whether or not engaged in providing day care (i.e., an allocable portion of the home mortgage interest and real estate taxes.)(6)

Thus, a portion of the personal expenditures of owning and using a residence, such as insurance, utilities, general maintenance and trash removal, as well as depreciation, may be deducted under Section 280A(c)(4). However, such deductions may only offset income from the activity and can never cause or increase a deductible loss from the endeavor. To the extent such expenditures are not deductible because of the limitation against loss, they may be carried over and deducted in future years, subject to the same limitations on deductibility.(7)

To be eligible for deduction, a home-use expense must be related to the use of the residence in the day care operation. Thus, lawn care expenses will be eligible for deduction only if the yard is used in the activity. Where any portion of the home is not used exclusively in the day care activity, Section 280A(c)(4)(C) requires an allocation of the home-use expenses to each portion of the residence (whether used in the activity or not). Home=-use costs attributable to a specific portion of the home must be apportioned directly to such portion. For example, repair of a window air conditioner in the master bedroom must be apportioned directly to that room. On the other hand, repairs to the main furnace would be allocable to all rooms as a general expense. Any reasonable allocation method may be used to allocate general home-use expenses. Allocations based on relative square footage or percentage of rooms used in the activity where all rooms in the home are of approximately equal sizes are acceptable under the regulations.(8)

The taxpayer's deduction (subject to the limitation against loss discussed above) is then calculated as the sum of the products obtained by multiplying the expenses allocable to each portion used in the activity by a fraction, the numerator of which is the number of hours such portion was used in the activity and the denominator of which is the total hours the portion was available for use.(9) The total hours available for use includes all hours available for business and personal use -- generally 24 hours per day, 168 hours per week or 8,760 hours for a full year (365 days x 24 hours per day).(10)

In Example 1, the allocated home-use expenses are deductible without regard to the limitation against loss. However, where the gross income (after deduction for trade or business expenses not related to use of the home) is insufficient to absorb all allocated home-use expenses, the expenses must be calculated and deducted in the following order:

1. home mortgage interest, property taxes and other expenses otherwise deductible whether or not the home is used in the business activity;

2. other home-use expenses not involving an adjustment to basis of property (i.e., depreciation or amortization); and

3. home-use expenses involving an adjustment to basis of property (i.e., depreciation).(11)

Once again, the costs in items 2 and 3 above are deductible only to the extent they do not cause or increase a loss from the activity and may be carried forward to the extent of the excess.

Where the residence is occupied for less than a full year, total hours available for use (the denominator in the above fraction) should presumably be computed based on the total number of days of occupancy.

Where some portions of the home are used in the day care activity more than others or where a room is temporarily taken out from service of the activity (i.e., for repairs or redecorating), the code and regulations give no alternative to the onerous prospect of maintaining a daily hourly log to substantiate the deduction.(12)

Revenue Ruling 92-3 Sheds Additional Light

In Revenue Ruling 92-3, the Service has clarified some of the previously troublesome issues regarding home-use costs of day care service providers. First, any room or portion of the home which is routinely used in the day care

activity and which is available for sue in such activity throughout the business day is considered as used throughout the entire business day. Thus, the taxpayer is not required to substantiate the specific hours of day care usage of any room or portion of the home fitting this criteria. Bathrooms, eating and napping areas meeting these usage tests are specifically covered by this exception. In most cases, this new rule greatly reduces the need to keep records regarding specific room usage.

The ruling also states that the occasional non-day care use of a room for a business day does not disqualify the room from being considered as regularly used in the activity. A literal reading of the ruling indicates that taxpayers must still keep track of room occasionally taken out of service for a business day, reducing the total number of annual business hours used accordingly.(13)

However, daily hourly usage need not be tracked for rooms meeting the routinely used and available for use requirement.

The ruling also clarifies the fact that "substantiated preparation and clean-up time" before and after the day care recipients are present in the home is to be included in the total hours of day care activity. The ruling's example includes one-half hour before and one-half hour after regular business hours for preparation and cleaning-up. Interestingly, the Tax Court has recently sanctioned, in addition to the time children were present in the home, two hours each morning organizing the facility and preparing meals, and one hour each evening cleaning and reorganizing the facility.(14)

The day care operator in the ruling's example has at least one child (other than their own) in the home at all times during the business day. However, such continuity of service is not specifically required by the ruling in order to define the business day. Although there is no direct authority on the issue, a short interval during the day where no children are present would seem to be includible as part of the business day when used for purposes of preparation and/or clean-up.

The ruling also confirms that the cost of basic local telephone service (the first telephone line) is a nondeductible personal expense, even though a telephone may be a state law requirement for day care providers and even though the phone is used substantially in the day care activity.(15) However, additional charges attributable to the activity, such as long distance calls or a second telephone line required by the business, are, of course, deductible as an operating expense of the business under Section 162.

The ruling does not discuss the treatment of a portion of the home which is routinely used and available to the day care operation for only part of the business day -- such a room or area used only in the morning until another family member comes home. Perhaps the best way to view this situation under the logic of the ruling is to consider the business day of such portion as being the time it is regularly available to the activity.

Also not addressed in the ruling is the situation where a portion of the home is used on a regular basis, but not available throughout the business day or some consistent portion of the day. It seems the only way to substantiate an hourly usage in such cases is to maintain a log for those areas.

Planning considerations

In order to eliminate constant recording of daily hourly usage of each portion of the residence used in the day care operation, it seems prudent to arrange the utilization of the home in a way complying with the routinely used and available for use throughout the day requirement of Rev. Rul. 92-3. Concentration of day care activities in certain areas of the home for continuous availability may be a better choice than using more areas on a less consistent basis.

Wherever possible, the schedule of day care attendees should be arranged such that at least one child is present at any particular time throughout the day. If this is not possible, any intervals should be used for purposes of preparation and/or clean-up. This step will strengthen the taxpayer's position that the services are provided -- and rooms are available to the activity -- throughout a continuous business day. In all cases, preparation and clean-up activities must be substantiated -- by far the best method being a daily log. Furthermore, the daily usage log must be kept for any portions of the home not meeting the consistency of use and availability requirements outlined in the ruling.

Finally, since none of the costs of basic telephone service is deductible, the taxpayer should consider a second telephone line dedicated to the business operation, especially where the telephone usage attributable to the day care operation is substantial and infringes on personal use. The tax deduction and added convenience may offset the additional cost of the extra telephone line.


Taxpayers in the business of providing day care services are permitted substantial deductions in connection with the use of their residence in such activity. Tax advisers should encourage their clients engaged in these activities to arrange and document the operation in order to comply with recent IRS clarification of the requirements for such deductions.

Example 1

A licensed day care service provider has the following gross income, operating expenses and home-use expenses for her home which is used 10 hours a day, 250 days a year, providing day care services. The home contains 3,000 square feet of area of which 1,800 square feet (60%) is regularly used in the activity. Net income from the activity is computed as follows:
Gross Income ($100 per day) $25,000
Operating Expenses (food, diapers, supplies, etc.) 7,000

Home-Use Expenses:
* Interest and Taxes 16,000
* Insurance, Utilities, etc. 6,000
* Depreciation(*) 5,000
TOTAL 27,000
x portion of residence used in the activity 60%

x hours used in activity total hours available for use
(2,500/8,760) 28.539%
Total deduction 4,623
Net income $13,377

* depreciation is calculated under Section 167 or Section 168 as if the home qualified for such treatment, then allocated to the activity.

Example 2

Same facts as Example 1, except the activity produces gross income of only $10,500 ($42 per day). Net income from the activity is computed as follows:
Gross Income ($42 per day) $10,500
Operating Expenses (food, diapers, supplies, etc.) 7,000

Home-use Expenses:
* Interest and Taxes 16,000
x portion of residence used in the activity 60%

x hours used in activity total hours available for use
(2,500/8,760) 28.539%
Amount deductible 2,740
* Insurance, Repairs, Utilities, etc. 6,000
x portion of residence used in the activity 60%

x hours used in activity
total hours available for use 28.539%
Amount deductible 760(1)
* Depreciation 5,000
x portion of residence used in the activity 60%

x hours used in activity
total hours available for use 28.539%
Amount Deductible -0-(2)

(1) $760 is deductible and the excess ($277) is carried forward.

(2) -0- is deductible and $856 is carried forward.

Example 3

Mary moved into her new home on August 1, 1991, and began her licensed day care services on October 1, 1991, using her home a total of 600 hours during the period October 1 through December 31. Her home-=use costs allocable to the day care activity are deductible (subject to limitation against loss) to the extent of such costs multiplied by a fraction which is 600 hours day care use, divided by 3,624 hours available for use (151 days of occupancy x 24 hours per day).

Example 4

The regular business day of a 10-room day care service provider is 7:00 a.m. to 5:00 p.m. (10 hours), not including preparation and clean-up time. However, two of the rooms available only until grandfather returns home at 12:00 noon. Thus, eight rooms have a 10-hour business day and two rooms have a five-hour business day (not including preparation and clean-up time).


1 Revenue Ruling 92-3, 1992-3 I.R.B. 1.

2 Section 280A(c)(4)(A)

3 Prop. Reg. Section 1.280A-2(f)(2). Such activities are considered as incidental for children up to kindergarten age, so long as not in lieu of compulsory state requirements.

4 Section 280A(c)(4)(B) and Prop. Reg. Section 1.280A-2(f)(3).

5 Prop. Reg. Section 1.280A-s(h)

6 Section 280A(c)(5). Of course, the nonbusiness portion of interest and taxes may be deductible as itemized deductions.

7 Section 280A(c)(5)(B).

8 Prop. Reg. Section 1.280A-2(i)(3).

9 Section 280A(c)(4)(C).

10. See Prop. Reg. Section 1.280A-2(i)(4).

11 Prop. Reg. Section 1.280A-2(i)(5).

12 In March, 1991, the Service issued TAM 9126003 which required an allocation based on actual hours each portion of the home is used in the day care activity. However, the TM was later suspended pending reconsideration by the Service.

13 The ruling also states that the occasional use of a room not ordinarily available to the activity is not to be considered as used throughout the business day. However, this rue seems superfluous in most cases since a room not ordinarily available for use in the activity would probably not meet the use on a regular basis requirement of Section 280A(c)(4).

14 Neilson v. Comm., 94 T.C. 1 (1990).

15 See also Section 262(b).

Richard W. Harris, MBA, CPA, JD, LLM, is an assistant professor of taxation in the Graduate Tax Program at The American University, Kogod College of Business Administration in Washington, D.C. His primary areas of teaching and research are estate and gift, corporate and partnership taxation.
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Title Annotation:tax deductions
Author:Harris, Richard W.
Publication:The National Public Accountant
Date:Oct 1, 1992
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