VACATION RENTAL HOME BENEFITS & TAX BREAKS
Personal Use and As a Rental Unit
Well here we are half way through the summer and many of us have taken a vacation … maybe at a pricey resort or just day trips to the beach, lakes or the mountains. In this article, we’ll take a look at a vacation destination that could deliver more than just rest and relaxation, i.e.:
- Less cost;
- Added revenue stream;
- Tax breaks; plus
- Potential for capital appreciation.
That briefly outlines the advantages of a second home when employed as a vacation rental. So if you own a second home, or the boost in the economy prompts you to consider a purchase, then this article is for you.
OK, so let’s get a few basic definitions out of the way and examine tax treatment based on the mix of personal and rental use of a property.
A Vacation Rental Home … Not Necessarily a House
When it comes to vacation rental homes, the Internal Revenue Service makes the distinction that the property is used as a residence as opposed to a property used for businesses, such as an office building or retail center. Perhaps surprisingly, the IRS considers a “dwelling unit” to be a home, apartment, condo, mobile home, boat, or any other structure containing sleeping space, toilet, and cooking facilities. So that expands your potential investment choices in vacation rentals.
Note: If the property is used on a transient basis, as a hotel room would be, the IRS does not recognize it as a dwelling unit.
Personal Use vs. Rental – Effect on Tax Benefits
There are limits on the type and amount of expenses that you can deduct depending on how often you use the property for personal use and how often you rent it to others.
In general, there are two types of expenses associated with a vacation home – trade or business (or production of income) expenses and deductible personal expenses. Deductible personal expenses are items that are deductible in their entirety, regardless of whether the vacation home is personal use or rental property. Expenses in this category include casualty losses, state and local property taxes, and interest.
The first limitation on the deductibility of expenses is that the expenses related to a trade or business or the production of income (rental expenses) are only deductible to the extent you do not use the home for personal use. Basically, that is the number of days the unit is rented divided by its use for any other purpose during the taxable year – excluding days for repairs and maintenance. The resulting number is the amount of expenses tentatively deductible as rental expenses. There is more to the story, but these are the basics.
A second limitation also applies if your personal use is so extensive that the dwelling unit is treated as your “residence” for tax purposes. If the number of personal use days exceeds the greater of (1) 14 days or (2) 10% of the number of days the unit was rented at fair rental value, then the dwelling unit is a “residence” and you may not deduct any rental expenses that exceed the gross rental income from the property. Any deductible personal expenses not deducted because of the gross income limitation are allowed as itemized deductions.
In a few cases you must treat someone else’s use as your own. These include any day in which the home was used by a(n):
- Member of your family,
- Co-owner,
- Member of a co-owner’s family,
- Individual who is renting for less than fair rental value, or
- Individual who is using your house under a “switching arrangement” that enables you to use another dwelling unit (such as switching a beach house and a mountain cabin).
It is important to note that family members’ use counts as your personal use even if they are paying fair rental value (unless they use the home for their primary residence). This is also true for the switching arrangement.
Rental Income and Tax Deductible Offsets
As previously mentioned, rental income generates an added revenue stream. Of course, that added income must be appropriately reported at tax time along with rent-related expense deductions.
Rent-related expenses may include such items as utilities, maintenance, upkeep, mortgage interest, real estate taxes and insurance. Additionally, the landlord may claim a depreciation deduction that relates to rental use. Interestingly, and often overlooked, is a deduction for the owner’s costs to travel to the vacation home on business connected to the rental.
Note: The Tax Cuts and Jobs Act include provisions that limit deductibility for acquisition debt and deductions for state and local taxes. There may be additional tax issues that could affect your unique tax status.
Takeaways
This article provides a basic overview of the definition of a dwelling unit and rules regarding vacation home rental expenses. There are other details to be considered. That said, if you own a second home and are thinking about using it as a rental property, or contemplating becoming a second home vacation rental landlord, I encourage you to call me to discuss your situation in more depth.
Pearson & Co. stands ready to help. Call or email … we’ll respond promptly!