Tax Rules for Renting out Your Vacation Home

Vacation homeowners may choose to rent out their properties to offset the expenses of ownership or to generate income. As a result, vacation homeowners could be entitled to certain tax benefits that may help make their vacation home more affordable.

However, the tax breaks are contingent on meeting several requirements, including the number of days each year that the property is rented out. Understanding the tax rules ahead of time can help vacation homeowners take advantage of tax breaks and avoid costly surprises at tax time.

Understanding the Tax Rules for Renting a Vacation Home

If a homeowner gets paid rental income, the income is taxed by the Internal Revenue Service (IRS). However, the homeowner can usually deduct certain expenses. The total amount of the expenses reduce the taxable rental income for the owner.

Vacation homeowners have specific rules that must be followed in order for the owner to be able to deduct expenses related to the rental property. Below is an overview of the requirements and rules for tax deductions for vacation homes.

The 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 IRS rules, 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 a 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.

Rented for More than 15 Days and Used 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 the following:

• Fees paid to property managers
• Insurance premiums
• Maintenance expenses
• Mortgage Interest
• Property taxes
• Utilities
• Depreciation

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." The deductible expenses are 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 they manage the property themselves. A passive loss is a loss that can be deducted if the taxpayer does not materially participate in the rental property.

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's important to track and document personal use days versus days used for repairs and maintenance. According to the IRS, personal use days can include:

Any day that you spend working substantially full time repairing and maintaining (not improving) your property isn't counted as a day of personal use. Don't 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 can be complex and change frequently, it may be helpful 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.