Vacation home owners may choose to rent out their properties to offset the expenses of ownership or to generate income. Depending on the number of days each year that a property is rented out, the owner may be entitled to certain tax benefits that may help make vacation-home ownership more affordable. Understanding the tax rules ahead of time can help vacation home owners take advantage of tax breaks and avoid any surprises at tax time.
SEE: Vacation Property Walkthrough
14-Day or 10% Rule
The tax benefits to which an owner may be entitled depends upon the number of days each year that the property is rented out, and how much time the owner spends in the home. If the vacation home is used exclusively for the owner's personal enjoyment (and it is not rented out at any time during the year), the owner can generally deduct real estate taxes and interest on a home mortgage. Like a primary residence, the costs associated with insurance, maintenance and utilities cannot be written off.
If the home is used for rental purposes, the homeowner will fall into one of three categories.
Property rented for 14 days or less each year
According to tax laws, a vacation property can be rented out for up to two weeks (14 nights) each year without the need to report the rental income. In this case, the house is still considered a personal residence so the owner can deduct mortgage interest and property taxes on Schedule A under the standard second home rules. However, the owner cannot deduct any expenses as rental expenses.
This tax break is sometimes called the "Masters exemption" since homeowners close to the Augusta National Golf Club can earn as much as $20,000 renting out their homes during the annual tournament – without having to report the income on their tax returns.
The owner rents out the property for 15 days or more and uses it for less than 14 days
In this case, the property is considered a rental property and the rental activities are viewed as a business. All rental income must be reported to the IRS and the owner can deduct certain rental expenses including:
- Fees paid to property managers
- Insurance premiums
- Maintenance expenses
- Mortgage Interest
- Property taxes
The amount of rental expenses that can be deducted is based on the percentage of days that the vacation home was rented out (called "rental days"). This is calculated by dividing the number of days the home was rented out by the total number of days the home was used (rental days plus personal use days). For example, if a vacation home had 120 total days of use, and 100 of those days were rental days, 83% of the expenses (100 rental days/120 total days of use) can be deducted against the rental income (the rental portion of the expenses in excess of the rental income cannot be deducted). The owner would not be able to deduct the remaining 17% of the rental expenses.
In addition to deducting rental expenses, owners may be able to deduct up to $25,000 each year in losses, depending on the adjusted gross income (AGI) of the owner, and passive losses can be written off if the owner manages the property himself or herself.
SEE: Rental Properties: Cash Cow Or Money Pit?
The owner uses the property for more than 14 days or 10% of the total days the home was rented
If personal days exceed 14 days or 10% of the number of days the home is rented (whichever is greater), the IRS considers the property a personal residence and rental loss cannot be deducted. Rental expenses, up to the level of rental income, as well as property taxes and mortgage interest can still be deducted.
Since the 14-day cutoff can have a dramatic effect on taxes, it is important to accurately keep track of, and document, personal use days versus 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."
The Bottom Line
Owners who rent out vacation homes may be able to take advantage of certain tax benefits, thereby making a second home more affordable. The tax laws provide very different benefits depending on the number of days that the property is rented out each year and the amount of time the owner uses the home. Since tax laws are complicated, it may be helpful (and prudent) to consult with a qualified tax specialist to gain a comprehensive understanding of the tax laws and to determine the best approach to renting out your vacation home.
SEE: Tax Deductions For Rental Property Owners