Vacationing is a great American pastime. Often, we find a favorite spot for vacationing that turns into a regular place to go each year. Some people make a deeper commitment by buying a vacation home and renting it out to cover the cost while they are not using it. The purpose is not necessarily to own a rental property as much as it is to make the vacation home affordable. Tax laws also see these uses differently. It’s important to understand how the IRS views these investments when planning how to use the property personally.
Let’s begin by defining what the IRS considers personal use:
- Use by the owner
- Use by the owner’s other family members (whether they pay fair market rent or not)
- Use by anyone else who pays less than market rent
- Use of the property by another party under a reciprocal sharing arrangement (whether the other party pays market rent or not)
Days devoted principally to repairs and maintenance are considered days of vacancy and are disregarded, even if family members are present while you work away.
Substantial personal use with minimal rental
Let’s define this as less than 15 days of rental income and more than 14 days of personal use during the year. The IRS considers this “minimal rental use” and the property a residence in this situation. None of the rental income is reported. However, none of the expenses connected to the rental are deductible either. As a residence, real estate taxes and mortgage interest may be deductible on Schedule A for taxpayers that itemize deductions.
Substantial personal use with more than 14 rental days
This category includes a vacation property rented for more than 14 days during the year with personal use that exceeds the greater of:
- 14 days or
- 10% of the rental days
The IRS still considers the property a residence in this situation. However, the tax reporting becomes more burdensome.
- All rental income is now reportable on Schedule E.
- Any direct rental expenses, such as rental fees and advertising, are deductible against the income.
- Mortgage interest and property taxes must be allocated between rental and personal use. The allocation of these expenses can be deducted against rental income on Schedule E. Allocation to personal use can be taken as an itemized expense on Schedule A.
- Other indirect expenses — maintenance, utilities, association fees, insurance, depreciation, etc. can be allocated between rental and personal use.
These allocated expenses can be deducted against rental income only to the point where net income reaches zero. Taxpayers can carry over excess allocable indirect expenses to future years to be used against rental profits.
The IRS considers a vacation home to be a rental property when it is rented out for more than 14 days during the year and personal use does not exceed the greater of:
- 14 days or
- 10% of the days it is rented out at fair market rates
Once again mortgage interest, property taxes, and other expenses must all be allocated between rental and personal use based on actual days of rental and personal occupancy. However, mortgage interest allocable to personal use will no longer be deductible on Schedule A. A rental property does not meet the definition of qualified residence interest for itemized deduction purposes. Taxpayers can potentially deduct the personal use portion of real estate taxes on Schedule A, subject to the limitation on itemized deductions for state and local taxes.
Allocable rental expenses that exceed rental income could generate a deductible tax loss. Unfortunately, for many taxpayers, the loss may be wholly or partially deferred due to passive activity loss rules. Taxpayers can generally deduct passive losses only to the extent they have passive income from other sources. Passive losses that are disallowed are carried forward to future tax years and can be deducted against years when there is enough passive income or when the property is sold.
Taxpayers should consider the implication of donating the use of their vacation property as a prize at a charity auction. There is no charitable write-off because the prize is only a partial interest in the property. Additionally, the time used by the winning bidder counts as personal use by taxpayer. This could cause the taxpayer to run into problems of classifying the property as a residence or rental when the owner’s personal use exceeds the greater of 14 days or 10% of days rented during the year.
- The IRS will consider a vacation home either a residence or a rental property based on how many days it is used as a rental vs. personal.
- Rental income from vacation homes rented less than 15 days during the year doesn’t need to be reported on tax forms.
- Many taxpayers will not be able deduct losses on a rental property due to passive income rules.
1. Tax Topic 415. For additional information see IRS publication 527.