Renting Your Vacation Home
If you currently own a vacation home, or are considering acquiring one, there are many tax implications to consider. Those tax implications are significantly impacted by your decision to rent your vacation home. While the additional income will help offset the cost of maintaining a second home, the amount of deductions that are allowed to offset the additional income can vary depending on the amount of days the home is rented versus the days the home is used for personal use.
Primarily Personal Use
If a vacation home is rented for fewer than 15 days throughout the year, the rental income can be collected tax-free. All real estate taxes paid on the property as well as the mortgage interest, assuming the rules for deducting qualified residence interest are met, can be deducted as itemized deductions on Schedule A. However, other expense related to renting the home, such as utilities, maintenance and depreciation, won’t be deductible.
Example: Friends pay you $1,000 to use your lakeside cabin for 10 days. You and your family use the home for the rest of the year. Assuming no further rental of the cabin in 2007, the $1,000 of income does not have to be reported on your tax return. The mortgage interest and real estate taxes can be deducted on Schedule A as itemized deductions.
Mixed Use
If vacation home is rented for more than 14 days in a calendar year, then the number of days the home is rented must be compared with the number of days the home is used for personal use. All rental income must be reported and deductions must be allocated between rental and personal days. Deductions for rental expenses are limited to the amount of rental income reported in the year. In essence, you cannot claim a loss from the rental of a mixed-use property. Any expenses in excess of rental income are carried forward to future years. In addition, expenses are applied against rental income in the following order:
Primarily Rental Use
When the personal use of a vacation home is less than 15 days or 10 percent of the total number of days rented, all rental income is reported and the rental expenses are allocated between personal and rental days. The difference with a primarily rented home is all allowable expenses may be used to offset rental income.
When a vacation home is used primarily for rental and the allocated rental expenses exceed the rental income, the amount of active participation in the rental activity must be determined. Generally, you materially participated int eh rental activity if you were involved in its operation on a regular, continuous and substantial basis (examples of material participation are approving new tenants, deciding on rental terms, and approving capital or repair expenditures). If the owner meets the material participation test, then a loss equal to the amount that rental expenses exceed rental income is allowed up to a maximum of $25,000 per year. The $25,000 loss is limited to individuals with adjusted gross income (AGI) less than $100,000 and is phases out for individuals with AGI between $100,000 and $150,000. If you do not materially participate in the rental activity, then any loss incurred may only be offset against other passive income (passive income does not include earned or portfolio income).
Numerous factors affect the reporting of rental income and expense for vacation homes. Each situation is different and should be carefully evaluated to determine the proper treatment for income tax reporting.