If you own a vacation home, you may choose to rent it out to offset the expense of owning that property, or to generate income. Depending on the number of days each year you rent out the home, you may be entitled to certain tax benefits. Understanding the rules ahead of time can help you take advantage of tax breaks and avoid any surprises next tax season.
The tax issues surrounding the rental of your vacation home depend on the number of days each year that the property is rented out, and how much time you, the owner, spend in the home. Basically, vacation rentals fall into one of three categories:
Home is Rented 14 Days or Less
If you rent the property out for 14 days or less during the year, then it’s not really “rental property” at all. In the right circumstances, this can produce significant tax benefits. Any rent you receive for those two weeks won’t be included in your income for tax purposes (no matter how substantial the amount). The downside to this is that you can only deduct property taxes and mortgage interest—no other operating costs and no depreciation. (Mortgage interest is deductible on your principal residence and one other home, subject to certain limits.)
Home is Rented 15 days or more
In this case, the property is considered a rental property and the rental activities are viewed as a business. All rental income must be therefore be reported to the IRS but you can deduct certain rental expenses — fees to property managers, maintenance costs, utilities, and depreciation, just to name a few. In order to deduct those expenses, you must first allocate your expenses between the personal use days and the rental days. For example, if the house is rented for 90 days and used personally for 30 days, then 75% of the use is rental (90 days out of 120 total days of use). You would allocate 75% of your maintenance, utilities, insurance, etc., costs to rental. You would allocate 75% of your depreciation allowance, interest, and taxes for the property to rental as well. The personal use portion of taxes is separately deductible. Note that you also may be able to deduct up to $25,000 each year in losses, depending on your adjusted gross income, and passive losses can be written off it you manage the property yourself.
Owner uses property for more than 14 days or 10% of the total days the home was rented
If you use the home personally for more than the greater of (a) 14 days, or (b) 10% of the rental days, you are using it “too much,” and you cannot claim your loss. In this case, you can still use your deductions to wipe out the rental income, but you cannot go beyond the income to create a loss. Any deductions you cannot use are carried forward and may be usable in future years. If you are limited to using deductions only up to the amount of rental income, you must use the deductions allocated to the rental portion in the following order: (1) interest and taxes, (2) operating costs, (3) depreciation.
14 days can have a dramatic effect on taxes. It is important to accurately keep track of, and document, personal use days, rental days, and days used for repairs and maintenance. According to the IRS, any day that is spent “working substantially full time repairing and maintaining (not improving) your property is not counted as a day of personal use. Do not count such a day as a day of personal use even if family members use the property for recreational purposes on the same day.”