If you own a vacation home, you've probably considered renting it out occasionally to help offset some of the costs. As it happens, Uncle Sam has considered this possibility too and is poised to collect some of that income depending on the number of days each year the property is rented.
First and foremost, pay attention to the 14-day rule, says Thomas A. Gorczynski, an enrolled agent in Phoenix. The proceeds from a vacation home that is rented out 14 days or less a year are nontaxable and don't need to be reported on your tax return no matter how much rent you charge. To qualify, the property must be your personal residence. A dwelling is considered a personal residence if the owner's use of the home each year exceeds the greater of 14 days or 10% of the days the home is rented to others at fair market value. Although you can't deduct rental expenses, you may be able to claim all or part of your mortgage interest and property taxes on Schedule A of your 1040 (opens in new tab).
The IRS's definition of personal use is broad, helping you to satisfy the 14-day rule. It includes days you or a family member uses the house. Also counted are days you let anyone else use the home at less than a fair rental. There is an important exception. Days spent maintaining, improving or repairing the property, or fixing it up for rental, don't count as personal use.
If you rent out the vacation property at fair market value for more than 14 days a year, the IRS considers you a landlord. In that case, your rental expenses can be deducted proportionately to the property's use as a short-term rental. How much you can deduct is determined by dividing the number of days you rented out the property by the combined total days of personal and rental use. For example, a homeowner whose property is used 100 days of the year, 75 for rentals and 25 for personal use, can deduct 75% of eligible expenses. The deductions can't exceed the total amount of rental income, which is reported on Schedule E of your 1040 along with rental-related expenses. You won't have to file Schedule C or pay self-employment tax unless you provide significant hotel-like services for guests, such as housekeeping or breakfast, Gorczynski says.
What if your vacation rental activity generates a loss? The tax law prohibits deducting rental losses for a personal residence, but the loss is not gone forever. It can be carried over and used to offset future rental income. If the vacation property is not a personal residence and you actively participate in the rental activity, you can deduct up to $25,000 of rental losses against your other income. This $25,000 allowance phases out as modified adjusted gross income exceeds $100,000 and disappears entirely once modified AGI reaches $150,000. Active participation means you make management decisions and you or your contractors provide services such as repairs and rent collection.
The ability to deduct rental losses (subject to the AGI limits) is why many vacation homeowners who rent out short term tamp down their personal use of the property. If you stay at your beach home in North Carolina for a week and spend part of each day sprucing it up for rental, you could argue that your entire visit is for rental use, especially if you have records to back it up. But if you want the home to be considered your personal residence so that the rental income is tax-free, then you'll want the number of days the property is rented out minimized instead.
Whichever way you go, Eric Bronnenkant, a certified public accountant and head of tax at Betterment, says keeping good records is key. This includes a calendar or log for tracking rental and personal days and writing down what you did when you stayed at the property. Hang on to receipts, including those for yardwork, housecleaning and repairs, and find an accountant who understands how vacation rental property is taxed. Those rules can quickly get complicated, especially if losses are involved.
Joy is an experienced CPA and tax attorney with an L.L.M. in Taxation from New York University School of Law. After many years working for big law and accounting firms, Joy saw the light and now puts her education, legal experience and in-depth knowledge of federal tax law to use writing for Kiplinger. She writes and edits The Kiplinger Tax Letter and contributes federal tax and retirement stories to kiplinger.com and Kiplinger’s Retirement Report. Her articles have been picked up by the Washington Post and other media outlets. Joy has also appeared as a tax expert in newspapers, on television and on radio discussing federal tax developments.
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