- Learn about rental income taxes on vacation home rentals for 14 days or less in a year.
- Discover the rules regarding taxes on homes rented for more than 14 days with minor personal use.
- Find information about taxes on vacation homes rented for more than 14 days with major personal use.
- Learn about taxes on the sale of vacation homes.
Do you have a second home in a resort area? Are you considering acquiring a second home or vacation home? With summer just around the corner, you may have questions about rental income tax for part-time vacation home rentals. The applicable rental rules include some interesting twists that you should know about before you begin renting.
Some people prefer to never rent out their homes. However, others find this to be helpful in covering the cost of the home. For a home rented out part-time, we must consider one of three rules, based on the length of the rental.
Home Rented for 14 Days or Less
If property owners rent out a property for 14 days or less in a year, the property is treated as if it were not rented out at all. The rental income is tax-free. The interest and taxes paid on the home are also still deductible as part of itemized deductions and within the usual limitations. In this situation, however, any directly-related rental expenses (such as agent fees, utilities, and cleaning charges) are not deductible.
This rule can allow for significant tax-free income. For instance, when someone rents their home as a filming location or during a major sports event such as the Super Bowl.
Home Rented For More Than 14 Days with Minor Personal Use
In this scenario, the owners rent the home out for at least 14 days. Their personal use of the home does not exceed the greater of 14 days or 10% of the rental time. The home’s use is then allocated as both a rental home and a second home.
For example, what if homeowners use a rental home for personal use 5% of the time? if so, 5% of the qualified mortgage interest and taxes on that home are treated as home interest and taxes. These costs may be deductible as itemized deductions. The other 95% of the interest and taxes, as well as 95% of the insurance, utilities, and allowable depreciation, count as rental expenses (in addition to 100% of the direct rental expenses).
What if the rental income minus the expenses results in a loss? Then, the loss is limited to $25,000 per year for a taxpayer with an adjusted gross income (AGI) of $100,000 or less. It is ratably phased out when AGI is between $100,000 and $150,000. Thus, if a taxpayer’s income exceeds $150,000, the rental loss cannot be deducted. The loss carries forward until the taxpayer sells the home, receives rental profit in a future year, or has gains from other passive activities that they use to offset the loss.
Home Rented For More Than 14 Days with Major Personal Use
In this scenario, homeowners rent the house out for more than 14 days. However, the owner’s personal use exceeds the greater of 14 days or 10% of the rental time. With such major personal use, taxpayers cannot claim a rental-related tax loss. For example, consider a home that has personal use 20% of the time and rental use for the remaining 80%. The rental income is first reduced by 80% of the combined taxes and interest. If the owner still makes a profit after deducting the interest and taxes, then taxpayers can deduct direct rental expenses and certain other expenses (such as the rental-prorated portion of the utilities, insurance, and repairs), up to the amount of the remaining income.
If the owner still realizes a profit, they can take a deduction for depreciation. However, this is also limited to the remaining profit. As a result, no loss is allowed, and any remaining profit is taxable. The interest and taxes from the personal use (20% in this example) are deducted as itemized deductions, subject to the normal interest and tax limitations.
What About Vacation Home Sales?
We consider vacation home rentals as personal-use properties. Gains from the sales of such properties are taxable, and losses are generally not deductible.
Unlike primary homes, second homes do not qualify for the home-gain exclusion. Any gain from a second home is taxable unless it served as the taxpayer’s primary residence for two of the five years immediately preceding the sale and was not rented during that two-year period.
In the latter scenario, the taxpayer does qualify for the home-gain exclusion, if he or she has not used that exclusion for another property in the prior two years. As a result, the home-gain exclusion can offset an amount of gain that exceeds the depreciation previously claimed on the home. This amount is limited to $250,000 for an individual or $500,000 for a married couple filing jointly (if the spouse also qualifies) depreciation does not qualify for any exclusion, however, and the income from depreciation recapture must be recognized.
Complicated tax rules exist related to the home-gain exclusion for homes acquired in a tax-deferred exchange or converted from vacation home rentals to primary residences. Homeowners may require careful planning to utilize the home-gain exclusion in such cases.
As an additional note, when a property owner rents out a home for short-term stays or when they provide significant personal services (such as maid services) to guests, the taxpayer likely will be considered a business operator rather than just an individual who is renting a home. If so, the reporting requirements will differ from those outlined above.
As with all tax rules, there are certain exceptions to be aware of. Want more information about this topic? Call Fiducial at 1-866-FIDUCIAL or make an appointment at one of our office locations to discuss your situation.