If you or your clients own a vacation home of any kind, you might rent out the place to tenants in the summer when you’re not using it.
The thinking here is that can defray the usual ownership costs and you might turn a tidy profit. Conversely, if you show a loss for the year, the loss may offset other high-taxed income, like wages from your job.
But the tax rules for vacation home rentals are tricky. Significantly, if your personal use exceeds certain tax law limits, you can’t deduct a loss for the year.
Let’s start with this basic tax premise. Naturally, rental income from a vacation home is taxable, but you can deduct expenses such as mortgage interest, property taxes, repairs, utilities, insurance and so on. (Depending on your situation, mortgage interest and property may otherwise be wholly or partially deductible on your personal return for a qualified residence.)
However, there’s a limit to this tax benevolence. Under the so-called “passive activity loss” (PAL) rules, you can only use losses from a rental activity to offset losses from other passive activities, with a limited exception.
Assuming you are an “active participant” in the rental real estate activity – for example, you make management decisions, interview tenants, arrange repairs, etc. -- the tax results depend on your income and the level of your family’s personal use. There are three main rules.
- If your income is $100,000 or below, the loss can be used to shelter up to $25,000 of other income if you keep your family’s personal use to a minimum. Specifically, the personal use can’t exceed the greater of 14 days or 10% of the rental time.
- If your income exceeds $150,000, you no longer qualify for the $25,000 loss write-off. Essentially, your total rental deductions can’t exceed your rental income, regardless of your personal use.
- If your income falls $100,000 and $150,000, things get really complicated. The $25,000 loss write-off is gradually phased out. The closer you are to the $150,000 level, the smaller your loss write-off, and vive versa. Therefore, if you’re near the $100,000 mark, you might reduce your personal use to increase the loss allowed under the PAL rules.
As you can see, the number of personal versus rental days can be critical. Just a few days here or there can make a big tax difference. Special rule: If you spend time at a vacation home fixing up the place or getting it ship-shape for the rental season, the day doesn’t count as personal day – even if the rest of your family tags along just to go swimming or boating.
Finally, be aware of another tax law exception: If the rental lasts activity lasts two weeks or less, you don’t have to report any rental income for tax purposes, nor can you claim any deductions.
It’s like a “wash” in the eyes of the IRS. This may be a good way to pocket some extra cash without any tax consequences.
Ken Berry, Esq., is a nationally known writer and editor specializing in tax, financial, and legal matters. During his long career, he has served as managing editor of a publisher of content-based marketing tools and vice president of an online continuing education company. As a freelance writer, Ken has authored thousands of articles for a...