Rental of Vacation Property
What are the tax consequences of renting out your vacation home for part
of the year?
The tax treatment depends on how many days it's rented and your level of personal use.
Personal use includes vacation use by your relatives (even if you charge them market rate
rent) and use by non-relatives if a market rate rent is not charged.
If you rent the property out for less than 15 days during the year, it's not treated as
“rental property” at all. In the right circumstances, this can produce significant tax
benefits. Any rent you receive isn't included in your income for tax purposes (no matter
how substantial the amount). On the other hand, you can only deduct property taxes and
mortgage interest—no other operating costs and no depreciation. (Mortgage interest is
deductible on your principal residence and one other home, subject to certain limits.)
If you rent the property out for more than 14 days, you must include the rent you receive
in income. However you can deduct part of your operating expenses and depreciation,
subject to the following rules. First, you must allocate your expenses between the
personal use days and the rental days. For example, if the house is rented for 90 days and
used personally for 30 days, then 75% of the use is rental (90 days out of 120 total days
of use). You would allocate 75% of your maintenance, utilities, insurance, etc., costs to
rental. You would allocate 75% of your depreciation allowance, interest, and taxes for the
property to rental as well. The personal use portion of taxes is separately deductible.
The personal use portion of interest on a second home is also deductible where (as is the
case here) the personal use exceeds the greater of 14 days or 10% of the rental days.
However, depreciation on the personal use portion isn't allowed.
If the rental income exceeds these allocable deductions, then you report the rent and
deductions to determine the amount of rental income to add to your other income. 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 the test: if you use it personally for more than the greater of
(a) 14 days, or (b) 10% of the rental days, you are using it “too much,” and you
cannot claim your loss. In this case, you can still use your deductions to wipe out the
rental income, but you cannot go beyond the income to create a loss. Any deductions you
cannot use are carried forward and may be usable in future years. If you are limited to
using deductions only up to the amount of rental income, you must use the deductions
allocated to the rental portion in the following order: (1) interest and taxes, (2)
operating costs, (3) depreciation.
If you “pass” the personal use test (i.e., you don't use the property personally more
than the greater of the figures listed above), 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. (The loss is “passive,” however, and may
be limited under the passive loss rules.)
Example: You rent a vacation home for 60 days and use it personally for 20 days.
You are paid rent of $8,000. Expenses are $6,000 in interest and taxes, $3,600 operating
costs, and $4,800 depreciation, for a total of $14,400. Personal use is 25% (20 out of 80
total use days). So 75% of expenses are allocated to rental ($14,400 × 75% = $10,800).
There is thus a rental loss of $2,800 ($8,000 income, $10,800 expenses). However, personal
use (20 days) exceeds the greater of (1) 14 days and (2) 10% of rental days (6). The loss
is thus disallowed. You can deduct only $8,000 of expenses (up to the rental income). You
must first deduct the rental portion (75%) of the interest and taxes ($4,500 (75% of
$6,000)), then 75% of the operating costs ($2,700 (75% of $3,600), which totals $7,200
($4,500 plus $2,700). You can then deduct only an additional $800 of depreciation.