The Internal Revenue Code has specific tax laws surrounding vacation homes that a taxpayer rents and also enjoys for personal use. Ultimately, the number of days rented versus days of personal use will impact tax reporting and to what extent expenses relating to the vacation home are deductible. The following highlights some of the most important aspects of these tax laws, but is not intended to be a complete discussion.
When a vacation home is rented for less than 15 days, it is considered a personal home, and you are not required to report the rental income; it is “tax-free.” The qualified mortgage interest and real estate taxes are included with a taxpayer's itemized deductions on the taxpayer's personal income tax return (Schedule A), subject to limitation. All other expenses related to the vacation home are considered nondeductible personal expenses.
For example: Jim owns a vacation home located on a golf course which hosts an annual PGA tournament. Jim rents his vacation home every year for two weeks (14 days) during the tournament for an annual sum of $60,000. As favored by the tax laws, Jim does not have to report any of the money received as income. Assuming Jim rented the home for the past five years, that’s $300,000 in his pocket tax-free! Jim is also able to include the qualified mortgage interest and real estate taxes with his itemized deductions on his personal income tax return.
When a vacation home is rented for more than 15 days, a taxpayer has to determine if it’s considered a residence by applying the personal use test from the IRS. The vacation home is considered a residence if the amount of days spent for personal use is more than the greater of:
- 14 days, or
- 10% of the total days rented to others
For example: Sally has a vacation home she rented for six months (180 days) and vacationed at for 20 days during the year. Sally’s vacation home is considered a "residence" because her 20 personal use days were more than the greater of 14 days or 10% of the days rented (18 days). In other words, her vacation home passed the personal use test.
When a vacation home is considered a residence, all rental income is reported on Schedule E. However, expenses are to be divided between rental use and personal use based on the number of days used for each purpose. In addition, rental related expenses are limited to the extent of rental income (cannot generate a tax loss). Expenses that are limited under this rule may be carried forward to future years but remain subject to the income limitation.
When a vacation home fails the personal use test (not considered a residence), the vacation home is considered a rental property, and deductions are not limited to income but are subject to passive activity rules.
For example: Using the same fact pattern above, assume Sally collected $12,000 of rental income which is reported on Schedule E. She also incurred $10,000 of property expenses during the tax year, which must be split between personal use and rental expenses. This bifurcation is accomplished by taking the rental days of 180 divided by 200 total days (180/200 = 90%). Thus, $9,000 ($10,000 x 90%) of the property expenses offset the rental income and are deducted on Schedule E. The balances of the expenses are considered nondeductible personal expenses.
The classification of a vacation home as a personal home, residence or rental is determined on a year-to-year basis. Therefore, it is important to maintain accurate records on a vacation home to document the number of personal days and days rented.
By Eric Wilson, CPA. If you have any questions regarding the rental of a vacation home, please contact Kirk Holderbaum, CPA, of WithumSmith+Brown, PC at 908.526.6363 x3311 or email firstname.lastname@example.org.