Abstract: What are the tax implications
when a taxpayer who owns a vacation home rents it out? The answer depends on
various factors, such as the amount of time rented out and the number of days
used by the owner. The calculation of taxable income can be complex. This
article explains.
Renting out your vacation
home? Know the tax implications
If you’re fortunate enough to own a vacation
home, you may want to rent it out when you’re not using it. But how might that
affect your taxes?
The answer lies in keeping good records. Before
you post the “for rent” sign, consider how many days you, your relatives (even
if they pay market rent) and nonrelatives use the home if market rent isn’t
charged.
Under 15 days
In the right circumstances, renting the
property out can produce revenue and significant tax benefits. If the property
is rented out for less than 15 days during the year, it’s not treated as
“rental property,” and the rent you collect isn’t included in your taxable income
at all. On the other hand, you can only deduct (as itemized deductions) property
taxes and mortgage interest — no other operating costs or depreciation.
(Mortgage interest is deductible on your principal residence and one other
home, subject to certain limits.)
If you rent the property out for more than 14
days, you must include the rent received in income. However, you can deduct
part of your operating expenses and depreciation, subject to certain rules.
First, you must 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, 75% of the use is rental (90 out of 120 total use days).
You may allocate to rental 75% of your costs
such as maintenance, utilities and insurance, plus 75% of your depreciation
allowance, interest and taxes for the property. The personal use portion of
taxes is separately deductible as an itemized deduction. The personal use part
of interest on a second home is also deductible (if eligible) where the
personal use exceeds the greater of 14 days or 10% of the rental days. However,
depreciation on the personal use portion isn’t allowed.
Claiming a loss
If the expenses exceed the income, you may be
able to claim a rental loss (subject to the passive activity rules), depending
on how many days you use the house for personal purposes. Here’s the test: If
you use it personally for more than the greater of 14 days or 10% of the rental
days, you’re using it “too much” and can’t claim your loss. In this case, you
can still 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 the deductions allocated to the rental portion in this
order: 1) interest and taxes, 2) operating costs 3) depreciation.
If you “pass” the personal use test, you must
still allocate your expenses between the personal and rental portions. In this
case, however, if your rental deductions exceed rental income, you can claim
the loss. (The loss is “passive” and may be limited under passive loss rules.)
Planning ahead
These are the basic rules. There may be other rules if
you’re considered a small landlord or real estate professional. Contact us if
you have questions. We can help plan your vacation home use to achieve optimal
tax results.
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2022