As the summer vacation season approaches, many taxpayers with second homes will seek to earn extra income by renting to vacationers.  If you own a second home that you are considering renting, you should understand the tax impacts.

A vacation home (or other property that is not your primary residence) is considered investment property if personal use is limited to no more than 14 days in a given tax year or, if greater, 10% of total days rented out at fair rental price. Expenses associated with renting property, such as repairs, maintenance, and utilities, are generally tax deductible in full*. If the 14 days or 10% threshold is exceeded, tax deductions for rental expenses are generally limited to the amount of rental income collected in that year. Deductions for expenses reduce the amount of rental income subject to taxation. Expenses must be divided between personal and rental use. To determine the proportion of an expense deductible against rental income, take the total number of days the property was rented at fair rental price and divide by the total number of days the dwelling unit was used (for either personal or rental purposes), then multiply by the total expense amount. Days the property was available for rent but not actually rented do not count toward this calculation.

A “personal use” day includes any day you spend occupying your vacation home. Exclusions apply for days spent fixing-up the property or preparing it for rental (if that is the primary purpose of your stay). Other circumstances that qualify as personal use include when the property is used by:

  • Anyone with a financial interest in the property unless it is rented out to another owner at fair rental price and used as their main home.
  • Any of your family member(s)or the family member(s) of anyone else with a financial interest in the property unless they pay fair rental price and use it as their main home.
  • Anyone under an agreement that lets you use some other dwelling unit in exchange.
  • Anyone renting the home from you at less than fair rental price.

Personal use count is not relevant if the vacation home was rented for less than 15 days in a given tax year. In this case, any rental income generated does not need to be reported. Conversely, any rental expenses incurred cannot be deducted. An exception to this deduction limitation exists for property taxes and qualifying mortgage interest, as these items may be deducted, if itemizing, on an individual’s return. In this case, any rental income collected is tax free. This benefit is not limited to vacation homes. Taxpayers can rent out their personal residence for two weeks or less and enjoy the same tax benefit.

If you are currently or plan on renting out a vacation home, it is best to keep an accurate record of personal use versus rental use days for the year. This, combined with accurate expense tracking and documentation, will help you maximize deductions for rental expenses and ensure compliance with tax regulations.

Please contact the professionals at Gilliam Bell Moser if you have any questions.

*Generally, losses from rental real estate may be used to offset income from other “passive activities” (i.e., not ordinary income like wages and interest). However, if a taxpayer is actively involved in managing the rental property, they are allowed to deduct up to $25,000 of rental losses against ordinary income subject to an income-based phase-out.