Owners of vacation homes often try to offset some of the homes’ costs by renting them out part of the year. If you’re planning to rent out your vacation home this year, you should consider the federal income-tax implications. Doing so can help you make the most of the available tax breaks.
Rental Rule Basics
If you personally use your vacation home for even one day during the year, that use triggers the tax law’s vacation home deduction limits. The potential tax benefits of renting a vacation home depend on the nature of the personal use and some specific time limits imposed by the tax law and IRS regulations. If all requirements are met, you may be able to claim at least some of your rental expenses.
Investment Property. If you personally use your vacation home no more than 14 days a year or 10% of the total number of days it is actually rented out, whichever is greater, the property is considered to be investment property. Expenses you can’t normally deduct for a personal residence -- depreciation, utilities, repairs, etc. -- are fully tax deductible to the extent of the percentage of the total expenses attributable to the time the property was rented during the year. Real estate taxes are deductible, as is mortgage interest attributable to the rental use. Any excess of your rental expenses over your rental income is considered a deductible loss for income-tax purposes.
However, the tax law’s "passive activity" rules apply. That means you may use your real estate rental losses only to offset other passive activity income unless you "actively participate" in managing the rental property. Then, you can apply up to $25,000 in rental losses annually against regular income. (The $25,000 deduction is phased out starting when your adjusted gross income reaches $100,000.) Active participation means regular and substantial involvement, such as approving tenants, arranging repairs, and deciding on lease terms. Accumulated nondeductible passive losses are allowed when the property is disposed of.
Example: Donna owns a vacation home that she rents out 200 days this year. She personally uses the property for 15 days. Since that is less than 10% of the rental use, the property is considered an investment property. Suppose Donna’s expenses attributable to the rental period exceed her rental income by $5,000. Donna may deduct the $5,000 passive activity loss only if she meets the tax law’s income and active participation requirements.
Personal Residence. If your personal use exceeds the 14-day/10% of rental days threshold, the vacation home is treated as a personal residence. The amount you can deduct for rental expenses such as utilities and maintenance is limited to the rental income minus the sum of (1) deductions attributable to rental use that are otherwise allowable whether or not the home is rented (for instance, qualifying mortgage interest and real estate taxes) and (2) deductions allocable to the rental activity but which aren’t allocated to the home itself (advertising costs, for example). While you cannot claim a loss, any disallowed excess rental expenses may be carried forward to a future tax year when there is sufficient rental income.
Example: Using the above scenario, suppose instead that this year Donna spends 21 days at her vacation home and rents it out for 200 days. Thus, Donna exceeded the 14-day/10% limit personal use limit because 21 days was more than 10% of the rental use during the year. Assuming that her $5,000 rental loss includes $3,000 paid for mortgage interest and taxes attributable to the rental period and no rental expenses that aren’t attributable to the use of the home, her disallowed loss is $2,000. She can carry over the disallowed loss and use it against the next year’s rental income.
Personal Use. When you use a vacation home for your personal pleasure, that use counts as personal use for purposes of the 14-day/10% limit.
Be careful, though. Whenever you or a family member use the property -- even if you’re just letting a relative stay overnight -- it counts as a personal-use day. However, time spent fixing up or cleaning your vacation home doesn’t count as personal use if that’s your primary reason for being there, even if you bring the whole family along.
Tax-free Rental Income
You may be eligible for a tax break if you rent out your vacation home for 14 days or less during the year, because you currently do not have to report the rental income on your tax return. But you cannot claim any deductions for maintenance, utilities, or depreciation either.
This break is not limited to vacation homes. If you own a principal residence in a prime vacation spot or popular event venue, renting your home to someone for less than 15 days during the year entitles you to enjoy the rental income tax free.
Tax Advice Is Essential
Before taking any steps toward renting a vacation residence, talk to us first. The vacation home tax rules are complicated, and our professionals can show you the best way to take advantage of the tax law’s provisions. Give us a call today.