Summer Rental Season Kicks Off - Extra Tax Points for Owners

By Ken Berry
According to Deloitte's new Summer Travel survey, more Americans will be traveling this upcoming Memorial Day holiday than they did last year. This could be welcome news to clients who own rental properties as the traditional vacation season kicks into high gear. But some dark clouds still loom on the horizon as Congress threatens to scale back tax breaks for vacation home owners.
The Deloitte survey of 1,000 respondents around the country shows that 31 percent plan to take a pleasure trip over the long Memorial Day weekend as compared to only 24 percent who said they traveled during the same weekend last year. Even more promising, more than half of the respondents – 54 percent – expect to take a trip between June 1 and Labor Day, up from 52 percent. Of these summertime travelers, 24 percent plan to spend more money on the road than they did last year, although 56 percent anticipate spending approximately the same amount. 
Are you confused by the rules for rental properties? Just imagine how your clients feel! Here are some of the main talking points:
  • If the vacation rental lasts for two weeks or less, no income is reported, but no rental deductions are allowed.
  • If the property is rented out for more than fourteen days and personal use doesn't exceed the greater of fourteen days or ten percent of the total rental days, the property is treated as a rental property.
  • A loss from a rental property is generally treated as a passive loss, but owners who "materially participate" in rental activities may be entitled to a $25,000 offset, subject to a phaseout between $100,000 and $150,000 of AGI.
  • If the property is rented for more than fourteen days, but also used personally for more than fourteen days or ten percent of the total rental days, expenses must be allocated between personal and rental use.
  • Congress could reduce the tax benefits currently available for second homes.
  • The rules are complex. Take the tax consequences into account when arranging vacation schedules.
"As consumers appear to feel more confident about the economy and the job market, we could see a steady uptick year-over-year in leisure travel during the summer months," said Adam Weissenberg, vice chairman, Deloitte LLP and global leader of its travel, hospitality, and leisure units. "This highlights the continued growth and vitality of the travel industry as a whole."
Increased travel activity could bolster vacation rentals for clients who own cottages or other property near the water or in the mountains or woods. But the tax rules can become tricky if the place is used both for personal and rental purposes. 
The easiest situation occurs if a client uses the property personally for more than fourteen days and rents it out fourteen days or less in a year. The rent isn't considered taxable income, even if the client charges top dollar. On the flip side, any rental and maintenance expenses can't be deducted, although the client may still write off property taxes and mortgage interest on Schedule A. Currently, qualified mortgage interest is deductible on a principal residence and one other home, up to the usual limits.
However, if a client rents out a home for more than fourteen days and personal use doesn't exceed the greater of fourteen days or ten percent of the total rental days, the property is treated as a rental property. Thus, all the rental income must be reported on Schedule E, but the client may still deduct expenses like management fees and the rental-related portion of mortgage interest, property taxes, homeowner insurance, maintenance, and depreciation. 
If the rental income exceeds the amount of rental income, your client has a tax loss, but it's treated as a passive loss. Typically, passive losses are limited to the amount of the client's passive income for the year, such as income from limited partnerships. Saving grace: If the client "materially participates" in the rental activity – for example, he or she manages the property and chooses the tenants – an offset of up to $25,000 is available. However, this tax break phases out for a taxpayer who has an adjusted gross income (AGI) of more than $100,000, and it disappears completely once AGI exceeds $150,000.
Things gets really complicated if the place is rented for more than fourteen days, but also used personally for more than fourteen days or ten percent of the total rental days. In this case, expenses must be allocated between the rental and personal use, but certain types of expenses are handled differently. When a client deducts mortgage interest and property taxes, all the days in which the home isn't rented are treated as personal use days. For other expenses, you figure the percentage based on the total number of days vacationed at the home plus the total rental days. The client can't claim passive losses, but losses may be carried forward.
What's Congress up to? There's been some talk of new allocation rules for rental properties, plus personal mortgage interest deductions for second homes could be on the chopping block. At this point, nothing is certain, but the outlook should clear up after the election.
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