Summer is just around the corner. If own a vacation home, you may wonder about the tax consequences of renting it out. The tax treatment depends on how many days you rent the property and your level of personal use. Personal use includes:
- Vacation use by your relatives even if you charge them market-rate rent
- Use by nonrelatives even if you don’t charge market rate rent
If you rent the property for fewer than 15 days in a year
If you rent the vacation home for fewer than 15 days during the year, it’s not treated as a rental property. You may experience tax benefits because any rent you receive isn’t included as income for tax purposes. Therefore, income from rent isn’t subject to tax.
However, your deductions are limited. You can only deduct property taxes and mortgage interest. You can’t deduct operating costs and depreciation. Mortgage interest is deductible on your principal residence and one other home, subject to certain limits.
If you rent your vacation home for more than 14 days in a year
If you rent the property for more than 14 days, you must include the rent you receive as income. And, you can deduct part of your operating expenses and depreciation, subject to several rules.
First, you must allocate your expenses between personal use days and rental days. For example, if you rent the house for 90 days and use it personally for 30 days, 75% of its use is rental. 90 ÷ 120 = 0.75
Therefore, you allocate 75% of your maintenance, utilities, insurance, and other costs to rental. You should do the same for allowance, interest, and taxes. The portion of taxes related to personal use is deducted separately. You may also deduct interest related to personal use if your personal use exceeds 14 days or 10% of the rental days, whichever is greater. Depreciation on the personal use portion isn’t allowed.
Personal use test
If the rental income exceeds these allocable deductions, calculate the rent and deductions to determine the amount of rental income to add to your other income. If your expenses exceed the rental income, you may be able to claim a rental loss. This is based on how many days you use the property personally.
If you use the home personally for more than 1) 14 days or 2) 10% of the rental days, you’re using it too much and can’t claim a loss. In this case, you can still use your deductions to eliminate rental income, but you can’t go beyond that to create a loss. But, you may carry forward any unused deductions and use them in future years. If the deductions can only offset rental income, you must use the deductions allocated to the rental portion in the following order: 1) interest and taxes, 2) operating costs, and 3) depreciation.
If you don’t use the property personally for more than 14 days or 10% of the rental days, you still need to allocate your expenses between the personal and rental portions. In this case, if your rental deductions exceed rental income, you can claim the loss. However, the loss is passive, and passive loss rules may limit it.
Have questions about renting your vacation home and the tax impact? Let’s talk!