If you own a vacation home, you might be thinking about renting it out at certain times. Before you do, make sure you know the tax consequences.
Tax treatment for vacation rentals can be complex. The impact depends on how many days the home is rented and your level of personal use. Personal use includes vacation use by you, your relatives (even if they pay market rent) and nonrelatives who don’t pay market rent.
Up to 15 days
If you rent the property for fewer than 15 days in a year, the IRS does not consider it a “rental property” at all. In the right circumstances, then, you can produce revenue with significant tax benefits. Any rent you receive is not included in your income for tax purposes. At the same time, you can deduct only your property taxes and mortgage interest, and no other operating costs or depreciation. (Mortgage interest is deductible on your principal residence and one other home, subject to limitations.)
If you rent the property for more than 14 days, you have to include the rent amounts received in your income. On the upside, you can deduct part of your operating expenses and depreciation, subject to rules. First, you must allocate your expenses between personal use days and rental days. If the house is rented for 90 days and used personally for 30 days, for example, 75 percent of the use is rental — that is, 90 out of 120 total use days. You would allocate 75 percent of your costs, such as maintenance, utilities, and insurance, to rental. You’d also allocate 75 percent of your depreciation allowance, interest, and taxes for the property to rental. The personal use portion of taxes is separately deductible. In addition, the personal use part of interest on a second home is deductible, if eligible, when personal use exceeds 14 days or 10 percent of the rental days, whichever is greater. Depreciation on the personal use portion isn’t allowed.
Claiming a loss
When rental income exceeds these allocable deductions, you report the rent and deductions to determine the rental income amount to add to your other income. If expenses exceed income, you may be able to claim a rental loss, depending on how many days you use the house for personal purposes.
Here’s the test: If you use the property personally for more than 14 days or 10 percent of the rental days, you’re using it “too much” and can’t claim your loss. You can use your deductions to wipe out rental income, but you can’t create a loss. Deductions you can’t use are carried forward and may be usable in future years. If you’re limited to using deductions only up to the rental income amount, you must use those deductions in this order:
Interest and taxes
Operating costs
Depreciation
If you “pass” the personal use test, you’ll still need to allocate your expenses between the personal and rental portions. In this case, you can claim a loss if rental deductions exceed rental income. (The loss is considered “passive” and may be limited under passive loss rules.)
Planning ahead
This information covers only the basic rules. Other rules may apply if you’re considered a small landlord or real estate professional.
Contact us if you have questions. We can help you plan how you use your vacation home for optimal tax results.