Summary: In this article, you will learn about the tax rules for vacation rental property. Topics include: vacation rental property tax deductions, IRS rules for rental property, the impacts of new tax rules and getting prepared for tax season.
The tax rules for a vacation rental property can be complicated. Because the IRS rules for rental property are so complex, we are going to stick to the key points and hopefully put them into terms that everyone can easily understand. If you would like to torture yourself and dive into some heavy reading, check out IRS Publication 527 for all the details.
Real estate tax rules vary greatly due to a number of factors. To determine the tax difference between a rental property, vacation home and residence, the IRS considers: how often it’s used and for what purpose. In other words, the number of days you personally use your vacation home and the number of days it’s rented out, will determine how you will be taxed.
Defining Personal Use of Property
The IRS defines personal use as, “use by the owner, owner’s family, friends, other property owners and their families. Personal use includes anyone paying less than a fair rental price.”
The days spent doing any maintenance on the property do not count against your personal use. Even staying at the property for a month, fixing it up, do not have to be reported to the IRS.
Vacation Rental Property vs Personal Residence
Your property is classified (and thus, taxed accordingly) by the number of days it’s personally used and the number of days it’s rented out.
- Your property is considered a business if you use your vacation home for 14 days or fewer in a year, or less than 10 percent of the days it’s rented.
- Your property is considered a personal residence if you use it for more than 14 days or more than 10 percent of the days it’s rented.
Vacation Rental Property Tax Deductions
The IRS only gives you a small break if your second home is rented out for 14 days or fewer, within a year. If you rent your home for less than 14 days, any income made is tax-free. No matter how much you make, you don’t even have to report rental income made. However, you can’t deduct any expenses on renting the property on your tax return.
Going past the 14 day limit or 10 percent of the total number of days it’s rented out (whichever is greater), you are required to report any rental income and pay taxes on it. The good news is, you can deduct rental expenses. This is where the tax rules get a little complicated.
Personal Residence: Home Used Mostly By Owner
If you rent out your property less than 15 days a year, it’s considered a personal residence. Because you aren’t required to report any rental income when you rent out the property for less than 15 days, you can’t deduct any expenses relating to the rental. However, you can claim homeowner deductions, such as,
- Mortgage interest
- Real estate taxes
- Casualty losses
Vacation Rental Property: Mixed Use By Owner and Tenant
As mentioned above, renting your property for 15 days or more per year qualifies your home as a vacation or rental. Expenses may be deducted, but must be prorated according to the amount of personal and rental use.
If you haven’t personally used your home to be considered a residence, you need to prorate any expenses from owning and maintaining the property. Use the following formula to prorate expenses:
Number of rental use days / Total number of days used for personal and business purposes.
For example, let’s say you used your vacation home for 60 days and rented it out for 120 days. You would then divide 120 by 180, giving you 67 percent. This means you can deduct 67 percent of qualifying expenses, up to the total rental income earned.
In this case, deductions for expenses are not limited by amount of rental income earned. Offset other income by using a rental loss. Keep in mind that deductible expenses can’t be greater than rental income.
Additionally, vacation rental property tax deductions can include depreciation of the asset. Any part of the home that is used for rental purposes is depreciating and may be deducted up to a certain amount.
What If My Home is a Residence?
Even if your home is a residence, and rented for at least 15 days, vacation-home rules still apply. This means your deductible expenses to rental income are limited. Deduct expenses in the following order:
- The rental portion of:
- Qualified home mortgage interest
- Real estate taxes
- Casualty losses
- Rental expenses directly associated to the rental property itself. This includes:
- Legal fees
- Office supplies
- Expenses associated with maintaining and operating rental property. You can deduct up to the amount of rental income, minus deductions from one and two above.
- Depreciation and other adjustments to home. You can deduct up to the amount of rental income, minus deductions from items one through three above. Examples include, improvements and furniture.
Don’t Forget About State Taxes and Local Laws
Laws and tax rules for vacation rental property vary from state to state. Some states collect sales tax, while others charge hotel taxes, even on short-term rentals. Check out your state and local government laws. But don’t stop there. It’s super important to looking local rules on permitting and any HOA rules regarding renting out all or part of your property.
Special Rules for Energy Efficient Vacation Homes Used as Residence
For properties that are in service before the year 2022, you can receive a personal tax credit if it’s energy efficient. Making your vacation or second home energy efficient and in service before January 1, 2020, receives a credit equal to the sum of 30 percent the amount paid for:
- Qualified solar electric property
- Qualified solar water heating property
- Qualified small wind energy property
- Qualified geothermal heat pump property
Tax Changes from the 2017 Tax Cuts and Jobs Act (TCJA)
These new tax laws are in effect until 2025. Below is the gist of the major changes:
- Homes bought from December 16, 2017, on, homeowners may deduct up to $750,000, down from $1 million.
- Interest on home equity loans can now be deducted only if the money was used for renovations on the property.
What to Do Come Tax Season
Vacation homes rented for more than 14 days annually would typically file a Schedule E along with your income tax return. Follow these six steps to file your vacation rental property tax form:
- Step 1: Report 100% of rental income on Schedule E of Form 1040.
- Step 2: Deduct 100% of any direct rental expenses (like management fees and advertising) on Schedule E.
- Step 3: Allocate mortgage interest and property taxes between rental and personal use.
- Step 4: Deduct as Schedule E rental expenses from step 3.
- Step 5: If any amount of net rental income is left over after completing step 4, you can deduct as indirect expenses such as, utilities, maintenance, insurance, depreciation, etc.
- Step 6: Write off personal use percentage of mortgage interest and property taxes. List these as deductions on Schedule A of Form 1040.
The tax rules for vacation rental property may seem overwhelming, especially if you’ve never done it before. If this is the case, I’d suggest getting some help from a CPA with experience in this area, to make sure your taxes are done correctly. However, if you feel like you have a good understanding of tax rules for vacation rental property after reading this article, use the steps above to file yourself. Visit the IRS’s website for any additional questions.