Has the IRS Disallowed Your Housing Allowance?
IRS Housing Expense Standard
The IRS has developed expense standards for housing and utilities. It is recognized by all that the housing expense standards used by the IRS are simply not realistic. They are based on BLS averages, which by definition, cannot take into account a given taxpayer’s specific facts and circumstances.
While the IRS uses these standards as a starting point for determining one’s ability to pay, code sec 7122(d)(2) provides:
The guidelines shall provide that officers and employees of the Internal Revenue Service shall determine, on the basis of the facts and circumstances of each taxpayer, whether the use of the schedules published under subparagraph (A) is appropriate and shall not use the schedules to the extent such use would result in the taxpayer not having adequate means to provide for basic living expenses.
How the IRS Housing Allowance Works
A house payment is a basic living expense. It cannot be opulent or extravagant, nor excessive under the circumstances. IRM section 126.96.36.199 describes what constitutes allowable expenses:
Allowable expenses include those expenses that meet the necessary expenses test. The necessary expense test is defined as expenses that are necessary to provide for taxpayer’s and his or her family’s health and welfare and/or production of income. The expenses must be reasonable.
Even if a taxpayer had to sell their home to accommodate the IRS’s averages, they must replace their home with rental property. A taxpayer will also be faced with moving expenses and they will lose the tax deduction for mortgage interest and real estate taxes, which increases their annual income tax liability. It does the IRS no good to disallow this expense; it does not increase the likelihood of collecting more tax over time.
A taxpayer faces a difficult real estate market if he chooses to comply with IRS wishes to sell the residence. Taxpayer may be forced into bankruptcy. A chapter 13 allows a taxpayer to sell the house at fair market value. It may regrettably be necessary for such filing destroying a stable living environment going forward.