Murphy v. Dept. of Rev.

• Court: Oregon Tax Court
• Decided: September 18, 2024
• Docket: TC-MD 230234R
• Status: Unpublished

Opinion

IN THE OREGON TAX COURT MAGISTRATE DIVISION Income Tax

JEFFREY M. MURPHY ) and DANIELLE J. MURPHY, ) ) Plaintiffs, ) TC-MD 230234R ) v. ) ) DEPARTMENT OF REVENUE, ) State of Oregon, ) ) Defendant. ) DECISION

Plaintiffs appealed Defendant’s Notice of Deficiency, dated August 24, 2022, for the

2019 tax year. A trial was held remotely on August 9, 2023. Ryan S. Johnson, CPA, (Johnson)

appeared on behalf of Plaintiffs. Jeffrey Murphy (Murphy) and Johnson testified on behalf of

Plaintiffs. Auditor, Khang Do appeared and testified on behalf of Defendant. Plaintiffs’

Exhibits 1 to 15 and Defendant’s Exhibits A to G were received into evidence.

I. STATEMENT OF FACTS

Plaintiffs owned two properties during the 2019 tax year for which they claimed

deductions for business expenses and depreciation: one in Bend, Oregon, (Sunstone property)

and another in Oregon City, Oregon (Meadowridge property). Defendant denied these

deductions, arguing, that Plaintiffs were not charging fair market rent (FMR) and that the

properties were treated as personal rather than for business purposes. The court will address

each property separately.

A. The Sunstone Property

Plaintiffs acquired the Sunstone property as an empty lot upon which they constructed a

3,066-square-foot, 4-bedroom 4.5-bathroom home. Plaintiffs received a Certificate of

DECISION TC-MD 230234R 1 Occupancy in August 2018. Murphy testified that the construction cost of Sunstone was

between $500,000 and $600,000 and that it was originally intended to be a short-term rental

property. Plaintiffs presented a “profit and loss budget” for Sunstone, estimating rental income

of $53,500 and operating costs of $35,308.

In January 2019, Plaintiffs began renting out Sunstone to friends and acquaintances by

word of mouth. Between January 2, 2019 and April 7, 2019, four separate guests stayed at the

property and were charged either $200 or $250 per night. Plaintiffs reported $1,900 in rental

income for the year. To determine the nightly rate, Plaintiffs looked at rents in the area,

including those at the Sunriver Resort. Murphy testified that the nightly rates were below the

area average due to the low winter season and guests were responsible for their own cleaning and

resort fees. Plaintiffs provided two comparable homes in January 2019 from VRBO in the Bend

area: a 4-bedroom home listed at $225 per night, and a 2-bedroom home for $163 per night.

Plaintiffs claimed $22,738 in total expenses and depreciation for Sunstone. Murphy

testified to visiting the property only a few times, primarily for cleaning and maintenance, and

that the property was otherwise used as a short-term rental. On their 2019 tax return, Plaintiffs

claimed cleaning and maintenance deductions of $540, which they later clarified were for snow

removal in the driveway. Citing the difficulty of maintaining a property over three hours from

their residence, Plaintiffs sold Sunstone in June 2019 for just over $1 million.

Defendant submitted comparable rentals for the Sunstone property, averaging $469 per

night. To calculate this figure, Defendant reviewed data from multiple sources over 12 months

to obtain an average nightly rate. This figure was then adjusted for the federal consumer price

index (CPI) and seasonal factors to estimate a rate for 2019. Specifically, Defendant used

VRBO data for weekday, two-night stays at comparable four-bedroom homes in the area from

DECISION TC-MD 230234R 2 January to December 2022. Defendant also looked at Airbnb listings for weekend stays from

June to December 2022 at homes with four to seven beds which showed rents more than double

what Plaintiffs charged.

B. The Meadowridge Property

Plaintiffs purchased Meadowridge in 2017 and used it as their primary residence.

Meadowridge is located in a gated community, on a golf course, and consists of a 5,586-square-

foot main building and a 2,556-square-foot attached additional dwelling unit (ADU). The

property includes amenities such as a saltwater pool, hot tub, and a sports court, all situated on

just under two acres of land. The ADU has two floors: the lower floor contains two bedrooms, a

bathroom, and kitchen, while the upper floor has a bedroom. Murphy testified that the upper

floor of the ADU was used for his spouse’s fitness business, and tenants could only access it with

permission.

Beginning May 1, 2017, Plaintiffs rented a room of the lower floor of the ADU on a

month-to-month basis to a tenant for $600 per month. On August 1, 2017, they added a second

tenant for $450 per month. Both tenants had full access to the property, including the pool, spa,

and outdoor living areas. The tenants remained on the lease until the property was sold in 2021.

Plaintiffs provided exhibits of comparable rental prices from Craigslist postings,

Rentdata.org, and letters from real estate professionals. The Craigslist posts showed properties

in the Portland metro and Vancouver areas offering rooms for rent ranging from $100-1900 per

month. (Id.) Rentdata.org showed the average cost for a two-bedroom unit in Oregon was $935

per month while for the average cost in Clackamas County was $1,441. Professional opinions

offered by Plaintiffs estimated a fair market price for a room to be between $500 and $700 per

month.

DECISION TC-MD 230234R 3 On their 2019 tax return, Plaintiffs reported $12,600 in rental income and $256,045 in

total rental expenses for the Meadowridge property, including depreciation of $194,299.

Plaintiffs depreciated all 2,556 square feet of the ADU, which included the second floor.

Defendant denied Plaintiffs’ rental expense deductions arguing the rent charged was

below fair market rent prices for comparable three-bedroom apartments. Defendant established

the fair market rent by analyzing the rental prices for three-bedroom units in Oregon City and

adjusting the rates using a 9.98 percent CPI factor to account for cost differences between 2019

and 2022. Defendant found that the analysis showed fair market rent for a three-bedroom rental

home to be $2,217 per month, whereas Plaintiffs received a combined $1,050 per month from

both tenants. Defendant’s RentData printout shows that the cost for a two-bedroom rental in

Clackamas County was $1,441. Defendant denied Plaintiffs’ depreciation of the Meadowridge

property on the grounds that it was not an income producing property.

II. ANALYSIS

The issues before the court are whether Plaintiffs may take business deductions for the

Sunstone and Meadowridge properties, and if so, in what amounts.

A. General Statements of Law

Oregon’s income tax is based on federal tax provisions, absent “modifications, additions

and subtractions” that do not apply here. ORS 316.048.1 The taxpayer, as the party seeking

affirmative relief, bears the burden of proof in this appeal. ORS 305.427.

A taxpayer may take a depreciation deduction for property held for the production of

income pursuant to Internal Revenue Code (IRC) section 167, which recognizes the exhaustion

and wear and tear of property. Olsen v. Comm’r, 121 TCM (CCH) 2021-41 (2021), 2001 WL

1 References to the Oregon Revised Statutes (ORS) are to the 2017 version.

DECISION TC-MD 230234R 4 1259727 at *8 (US Tax Ct). Additionally, a taxpayer may deduct all ordinary and necessary

expenses paid or incurred for the production of income or the management and maintenance of

property held for income generation. 26 USC § 212. For each of the above deductions,

taxpayers must demonstrate a profit motive and provide evidence of the property’s use for

income-producing purposes during the tax year.

B. Sunstone Property

Defendant denied Plaintiffs’ related deductions and depreciation for the Sunstone

property on the basis it was used for personal rather than business purposes. The court must

determine whether the property was rented at fair market rent and whether Plaintiffs treated it as

a business rental property.

Under IRC section 280A, a property is deemed to have been used for personal purposes

unless it is rented at fair market value under the specific facts and circumstances. Lee v. Dept. of

Rev., 9 OTR 447, 449 (1984). Defendant argues that the property was rented at less than fair

market rent, indicating personal use rather than an income-generating activity.

Plaintiffs’ business plan was to rent Sunstone for five nights each month from January to

April, at nightly rates of $200 for January to March and $250 for April. This totals to earnings of

$1,000 or $1,250 per month and for each of these months, the anticipated operating cost was

$3,059. However, they charged between $200 and $250 for nightly stays and had just four

guests over this period.

Plaintiffs’ evidence, including letters from a real estate professional, was not persuasive.

While rental comparisons are useful, the property’s amenities and values in the immediate area

are crucial in determining rental value. Given that Sunstone is a brand-new home, valued at over

$1 million, the court finds it unlikely that the fair market rent would be as low as $200 to $250

DECISION TC-MD 230234R 5 per night. Plaintiffs’ profit estimates at their suggested rental value appear too optimistic, as the

amounts for mortgage, taxes, and HOA dues appear unreasonably low.

When a taxpayer recognizes that they are charging below fair market rent, this

undermines their claim to an income-producing activity. Jasionowski v. Comm’r, 66 TC 312,

322 (1976). In this case, Murphy’s acknowledgement that they charged below fair market rent

disfavors Plaintiffs. While they claimed that the low season for the area was a factor to their

pricing, the court agrees with Defendant that the area remains attractive in winter due to the

popular nearby winter sports. Therefore, the court concludes that Plaintiffs did not charge fair

market rent for the Sunstone property.

A taxpayer’s efforts to rent property are also indicative of whether it was treated as a

business. See Newcombe v. Comm’r of Internal Rev., 54 TC 1298, 1300 (1970); see also

Robinson v. Comm’r, 2 TC 305, 307 (1943). Plaintiffs relied solely on word-of-mouth rentals

and did not market the property as a business would. Limited advertising to friends and family

does not constitute a diligent or bona fide efforts to rent the property. Godard v. Dept. of Rev.,

TC-MD 210354N, 2022 WL 1043982 at *5 (finding that limited advertising to friends and

family did not constitute diligent and bona fide efforts to rent the property). Plaintiffs’ lack of

use of professional rental management services or of making the property available to the general

public supports Defendant’s claim that Sunstone was used for personal purposes. Thus, the court

finds that Plaintiffs did not treat Sunstone as a business property, and Defendant’s denial of their

business deductions was appropriate.

C. Meadowridge Property

Defendant denied Plaintiffs’ deductions and depreciation for the Meadowridge property,

arguing it was used for personal instead of business purposes. To determine whether the

DECISION TC-MD 230234R 6 property qualifies as a rental property or personal residence, the court must first assess whether

Plaintiffs charged fair market rent.

Plaintiffs argued the Meadowridge property should be considered two individual room

rentals, rather than a two-bedroom unit, while Defendant asserted it should be treated as at least a

two-bedroom unit. The evidence showed two individual tenants occupying separate bedrooms

but sharing common areas (living room, kitchen, and bathroom). Plaintiffs’ decision to rent the

property as individual rooms was ultimately Plaintiffs’ choice. However, under property tax

appraisal standards, the highest and best use of the property would be to rent the unit as a two-

bedroom unit. In accordance with these standards, the court finds that the Meadowridge property

should be evaluated as a two-bedroom unit.

Fair market rent is determined by comparable rental prices and by the particular “facts

and circumstances.” 26 USC § 280A(d)(2)(c). Plaintiffs submitted a letter from a real estate

agent who used “The Way Back Machine” to view archive room rental listings on Craigslist.

However, this evidence had several issues: it lacked specific parameters, covered the entire

Portland metropolitan area (where location is key in real estate), and provided no property details

or photos. Another letter from a real estate broker offered rent estimates between $500 and $700

per room, but the court finds this evidence lacking in sufficient detail to be persuasive.

Defendant submitted comparable rentals for studio, one-bedroom, two-bedroom, and

three-bedroom rentals. However, like the Plaintiffs’ evidence, most of Defendant’s data covered

the entire Portland metropolitan area, not Oregon City Specifically.

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DECISION TC-MD 230234R 7 Defendant’s RentData printout concludes that a two-bedroom rent would be $1,441.

While the court found this data insufficient to precisely calculate fair market rent, it is persuasive

that Plaintiffs were not charging fair market rent. Consequently, Plaintiffs are not eligible to

deduct their expenses as business expenses.

III. CONCLUSION

After careful consideration, the court finds that Plaintiffs did not charge fair market rent

for either of their two properties and, as such, may not deduct expenses or take depreciation.

Now, therefore,

IT IS THE DECISION OF THIS COURT that Plaintiffs’ appeal of Defendant’s Notice of

Deficiency for the 2019 tax year is denied.

RICHARD DAVIS MAGISTRATE

If you want to appeal this Decision, file a complaint in the Regular Division of the Oregon Tax Court, by mailing to: 1163 State Street, Salem, OR 97301-2563; or by hand delivery to: Fourth Floor, 1241 State Street, Salem, OR.

Your complaint must be submitted within 60 days after the date of this Decision or this Decision cannot be changed. TCR-MD 19 B.

This document was signed by Magistrate Richard Davis and entered on September 18, 2024.

DECISION TC-MD 230234R 8