It has become increasingly common for people with vacation homes to consider renting the home out to others when not in use, in order to earn some additional income and offset some of the cost of ownership. There are many considerations related to this, such as insurance, marketing, management, risk of additional wear and tear, and last but not least – potential income tax consequences.
What are the income tax consequences of renting out a vacation home?
The tax treatment can be complex. It depends on how many days it’s rented and your level of personal use. Personal use includes vacation use by you, your relatives (even if you charge them market rent), and use by nonrelatives if a market rent isn’t charged.
The 15-day rule
If you rent your property out for less than 15 days during the year, it’s not treated as a taxable “rental property”, and the rent you receive isn’t included in your income for tax purposes at all. However, you cannot deduct any expenses such as operating costs or depreciation. Subject to certain limitations, you may still be able to deduct the mortgage interest and property taxes if you itemize deductions.
If you rent the property out for more than 14 days, you must include the rent received as taxable income. When renting for more than 14 days, you are allowed to deduct part of your operating expenses and depreciation, subject to certain rules. Operating expenses include advertising, cleaning, repairs, property management, utilities, property taxes, etc. To deduct a portion of these operating expenses, you must first allocate your expenses between the personal use days and the rental days. For example, if the house is rented for 91 days and used personally for 39 days, 70% of the use is rental (91 out of 130 total use days). You’d allocate 70% of your operating costs and depreciation as expenses to offset against the rental income. The remaining personal use portion of real estate taxes is separately deductible subject to certain itemized deduction limits. The remaining personal use portion of mortgage interest on a second home is also deductible (if eligible) where the personal use exceeds the greater of 14 days or 10% of the rental days. However, no depreciation expense is allowed on the personal use portion.
Can a loss be claimed on a vacation home rental?
If your rental income exceeds these allocable deductions, you will need to report the gross rental income and deductions to determine the amount of net rental income to add to your other income on your tax return. If the expenses exceed the income, you may be able to claim a rental loss. This depends on how many days you use the house for personal purposes.
Here’s how it works: if you use it personally for more than the greater of a) 14 days, or b) 10% of the rental days, you’re using it “too much” and can’t claim your loss. In this case, you can still use your deductions to zero out rental income, but you can’t create a loss. Deductions you can’t use are carried forward and may be usable in future years. If you’re limited to using deductions only up to the rental income amount, you must use the deductions allocated to the rental portion in this order: 1) interest and taxes, 2) operating costs, and 3) depreciation.
If you do not use it personally for more than the greater of a) 14 days, or b) 10% of the rental days, you must still allocate your expenses between the personal and rental portions. In this case, however, if your rental deductions exceed rental income, you can claim the loss. This loss is “passive,” however, and may be limited under passive loss rules.
How does vacation home rental income get reported?
Most often, a vacation home rental will be reported on Schedule E of your individual income tax return. When reported on Schedule E, the income is not subject to self-employment tax. In rare instances, such as if you provide “substantial services” to guests (such as daily maid service, concierge services, or meals), the income may need to be reported on Schedule C as a trade or business.
If you would like to discuss the impact of renting out your vacation home, please contact your tax representative at Wegner CPAs.