## Facts

- New York amended its Real Property Tax Law to label certain residential tenants as having a statutory “tax interest” in rented property and as “personally liable” for real-property taxes.
- Tenants were required to make two monthly payments to the landlord: one labeled rent and one labeled real-property tax.
- The statute sought to allow tenants to treat the “tax” portion as real-property taxes for federal income tax purposes.
- The landlord remained responsible for ensuring all real-property taxes were paid and was required to apply the first money received each month to those taxes.
- If a tenant failed to make the “tax” payment or the unit was vacant, the landlord was deemed to assume the tenant’s “interest” and remained responsible for the taxes.
- The IRS issued an administrative ruling addressing (i) tenant deductibility under I.R.C. § 164(a) and (ii) landlord income inclusion under I.R.C. § 61(a).

## Issues

1. Whether tenants may deduct, under I.R.C. § 164(a)(1), amounts paid to landlords that are labeled as real-property taxes under state law when the landlord remains the party responsible for payment of the tax.
2. Whether landlords must include in gross income under I.R.C. § 61(a) amounts received from tenants that are labeled as real-property tax payments, and whether landlords are the proper taxpayers to claim the I.R.C. § 164 deduction for the property taxes paid.

## Decision

- Tenants may not deduct the amounts labeled as real-property taxes; for federal purposes the payments are treated as part of rent rather than taxes paid by the tenants.
- Landlords must include both the “rent” and “tax” portions of the tenant payments in gross income as rental income.
- Landlords, as the parties who bear the real-property tax obligation in substance, may deduct the real-property taxes they pay under I.R.C. § 164.

## Legal Principles

- Federal income tax characterization is determined by federal law; state-law labels and purported reallocations of liability do not control federal deduction entitlement.
- A deduction for real-property taxes under I.R.C. § 164 generally requires that the tax be imposed on, and borne in substance by, the taxpayer claiming the deduction.
- Payments from a tenant to a landlord designated for the landlord’s expenses (including real-property taxes) are ordinarily rental income to the landlord, with the landlord claiming the corresponding deduction when the expense is paid.
- Substance-over-form applies where statutory or contractual re-labeling attempts to shift a federal tax benefit without shifting the underlying tax burden.

## Conclusion

The IRS determined that New York’s statutory re-labeling of part of tenants’ rent as real-property tax did not shift federal deduction rights: tenants could not claim a § 164 real-property tax deduction, landlords had to include the full amounts received as rental income under § 61, and landlords—not tenants—could deduct the real-property taxes they paid under § 164.


Rev. Rul. 79-180, 1979-1 C.B. 95 (1979)