Do you own a vacation home, cabin, or cottage? With summer just around the corner and the weather warming up, you may consider renting it out for some extra income. Before you do so, you should consider the tax consequences of doing so.
Do I need to include on my tax return?
Whether or not you need to include the rental activity on your tax return is determined by the number of days it is rented and your level of personal use. Personal use is not just your use as the owner. It also includes use by your relatives, even if you charge them the market rent rate, and use by others if you do not charge market rate rent.
Did you rent out the property for less than 15 days during the year? Good news – the property would not be treated as a rental at all. This means any rental income you receive is not included as income on your personal tax return, no matter how substantial. Only the property taxes and mortgage interest would be deductible on your return. Mortgage interest is deductible on your personal residence and one other home, subject to certain limits.
Did you rent the property out for more than 14 days? Under this scenario, you must report the rental income you received as income and include it on your personal tax return. Although you are adding income, you also get to deduct more of the operating expenses associated with owning and upkeeping the property.
These expenses must be allocated based on personal use days and rental days. For example, if you rented the property for 90 days and used personally for 30 days, 75% of the use is considered rental and you would be able to deduct 75% of the expenses associated with operating the property like maintenance, utilities, insurance, etc. You would also get to deduct 75% of the depreciation, property taxes, and mortgage interest for the rental as well. The personal use portion of the taxes and mortgage interest is also deductible, subject to some limitations.
Where is this reported on my tax return?
Rental activity is reported on Sch E of Form 1040. This is where you would report the rental income and allowable deductions. If the rental income exceeds the deductions, the net income is included in your income. If the expenses exceed the rental income, you may be able to claim a rental loss, but this depends on how many days you used the property personally.
If your use is considered personal for more than the greater of 1) 14 days or 2) 10% of the rental days, you are using it “too much” – you can’t claim the loss. You can use the expenses to reduce rental income to zero, but any remaining loss will be carried forward to be used in future years. The expenses are used in the following order: 1) interest and taxes, 2) operating costs, 3) depreciation.
If the above does not apply (i.e., you don’t use the property personally more than the limits), you may be able to claim the loss. However, the loss is considered “passive” and may be limited under the passive loss rules.
If you have a property you are considering renting out, contact us to ensure you are maximizing your deductions and prevent any surprises when tax season comes around.