Treated as Rental Property

Your home will fall under the tax rules for rental properties rather than for personal residences if you rent it out for more than 14 days a year, and if your personal use doesn’t exceed (1) 14 days or (2) 10 percent of the rental days, whichever is greater.

Example — You rent your beach cottage for 240 days and vacation 23 days. Your home will be treated as a rental property. If you had vacationed for one more day (for a total of 24 days), though, your home would be back under the personal residence rules.

Income: Rental income generated should be fully included in gross income.

Expenses: Interest, property taxes and operating expenses should all be allocated based on the total number of days the house was used. The taxes and interest allocated to personal use are not deductible. In the example above, the total number of days used is 263, so the split would be 23/263 for personal use and 240/263 for rental.

Any net loss generated will be subject to the passive activity loss rules. In general, passive losses are deductible only to the extent of passive income from other sources (such as rental properties that produce income); but if your modified adjusted gross income falls below a certain amount, you may write off up to $25,000 of passive-rental real estate losses if you “actively participate”. “Active participation” can be achieved by simply making the day-to-day property management decisions. Unused passive losses may be carried over to future years

Planning Note: Because the mortgage interest allocated to your personal use (23/263 in the example) is not deductible on Schedule A, it may be beneficial to use that additional vacation day. If your personal use does exceed the greater of (1) 14 days, or (2) 10 percent of rental days, the special vacation home rules apply. This means you drop back into the personal residence treatment, which allows you to deduct the interest and taxes and usually wipe out your rental income with deductible operating expenses. This is explained in greater detail below.

Treated as Personal Residence

If you use your vacation home for both rental and a significant amount of personal purposes, you generally must divide your total expenses between the rental use and the personal use based on the number of days used for each purpose. Remember that personal use includes use by family members and others paying less than market rental rates. Days you spend working substantially full time repairing and maintaining your property are not counted as personal use days, even if family members use the property for recreational purposes on those days.

Rented 15 days or more. If you rent out your home more than 14 days a year and have personal use of more than (1) 14 days or (2) 10 percent of the rental days, whichever is greater, your home will be treated as a personal residence.

Income: You must include all of your rental receipts in your gross income.

Expenses:

Interest and Taxes — Mortgage interest and property taxes must be allocated between rental and personal use. Personal use for this allocation includes days the home was left vacant.

Example: You rent your mountain cabin for four months, have personal use for three months, and it sat empty for five months. The amount of interest and taxes allocated to rental use would be 33 percent (4 months/12 months) and since vacant time is considered personal use, you would allocate 67 percent (8 months/12 months) to personal use. The rental portion of interest and taxes would be included on Schedule E and the personal part would be claimed as itemized deductions on Schedule A.

Operating Expenses: Rental income should first be reduced by the interest and tax expenses allocated to the rental portion (33 percent in our example above). After that allocation is made, you can deduct a percentage of operating expenses (maintenance, utilities, association fees, insurance and depreciation) to the extent of any rental income remaining. Please note though that, when calculating the allocation percentage for operating expenses, vacancy days are not included. Any disallowed rental expenses are carried forward to future years.

Planning Note: It would be wise to try to balance rental and personal use so that rental income is “zeroed” out as, even though losses may be carried forward, they often go unused due to lack of income. Mortgage interest should be fully deductible on Schedule A as a second residence. If more than two homes are owned, choose the vacation home with the biggest loan as the second residence. Property taxes are always deductible no matter how many homes are owned.

Rented fewer than 15 days. If you have the opportunity to rent your home out for a short period of time (

Income: You do not include any of the rental income in gross income.

Expenses: Interest and taxes are claimed on Schedule A. You can not write off any operating expenses (maintenance, utilities, etc. . . . ) attributable to the rental period.

Planning Note: Take advantage of this “tax-free” income if you get the chance. Short-term rentals during major events (such as the Olympics) can be a windfall.

David L. Schultz, CPA, ABV is a partner in the firm of Schultz, Chaipel & Company and can be reached at (941) 939-5333.