A vacation home rental during the weeks the property sits empty can bring in extra income. But it can also affect your taxes. The outcome depends largely on how many days you rent the property versus how many days you use it yourself.
The 14-day rule
In some cases, a vacation home rental can actually produce tax-free income. If you rent out the home for 14 days or fewer during the year, you generally don’t have to report the rental income on your tax return.
The downside is that the IRS limits your deductions. If you itemize, you can still deduct property taxes and qualified mortgage interest. However, you can’t deduct operating expenses or depreciation. Keep in mind that the state and local tax cap applies to the property tax deduction. Also, you can only deduct mortgage interest on your principal residence and one additional home, within certain limits.
When your vacation home rental exceeds 14 days
If you rent out the home for more than 14 days during the year, you generally must report the rental income as taxable. On the plus side, you can then deduct a portion of your operating expenses and depreciation, subject to certain rules.
You must divide expenses between personal use and rental use. Suppose you rent the home for 90 days and use it yourself for 30 days. Rental use makes up 75% of the total (90 of 120 days). In that case, you can allocate 75% of your costs to the rental activity. This includes maintenance, utilities, insurance, depreciation, interest and property taxes.
You can still deduct the personal use share of property taxes as an itemized deduction. The personal use share of interest on a second home may also qualify. However, your personal use must exceed the greater of 14 days or 10% of the rental days, and you must meet the home mortgage interest rules. You can’t take depreciation on the personal use portion.
Can you claim a loss?
What if your deductible expenses exceed the rental income? You may be able to claim a rental loss, but it depends on how the property is classified. Here’s the test: does your personal use exceed the greater of 14 days or 10% of the rental days? If so, the IRS generally treats the home as a personal residence. In that case, your rental deductions can’t create a loss. They’re capped at the amount of your rental income. You can carry unused deductions forward to future years.
If your personal use falls below that threshold, the IRS treats the home as a rental property. You still need to split expenses between personal and rental use. But if your rental deductions exceed your rental income, you can potentially claim the loss. Keep in mind that the loss is “passive,” so passive loss rules may limit it.
Moving forward
Vacation home rental tax rules can get complicated. Additional rules may apply if you qualify as a real estate professional or own multiple rental properties. Contact us with any questions.