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Vacation Home Rental Write-Offs Get Personal

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Clients who rent out vacation homes can generally write off qualified vacation home expenses. However, if their personal use exceeds the tax law limits, they can’t deduct an annual loss. This could affect the way they use their vacation home the rest of 2021.

Jul 19th 2021
Columnist
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Are your clients back to spending more time at their vacation home this summer?  They should know that if they rent out the home part of the time, this might cause tax complications. Let’s start with the basic rules and dig in deeper from there.

Basic rules: Normally, rental income from a vacation home is taxable, but certain expenses—like mortgage interest, property taxes, repairs, utilities, insurance, etc.—may be deducted against the income. (Depending on their situation, mortgage interest and property taxes may otherwise be wholly or partially deductible on their personal return for a qualified residence, subject to other tax law limits).

If their annual rental is for just two weeks or less, they don’t have to report any rental income to the IRS, nor do they deduct offsetting expenses. But things get a little trickier if they rent out the place for more than 14 days and still use it personally. In this case, they must pay tax on all of the rental income, while they can deduct only a portion of their expenses.

Significantly, they must allocate costs between “business use” and “personal use” days. Each day the home is rented to a stranger at a fair rate counts as a business use day. Conversely, if they spend a day of R&R at the home, it counts as a personal use day.

Example: They rent out the vacation home for 80 days in 2021 and the family uses it personally for 20 days. Accordingly, they can deduct 80 percent of their qualified rental expenses (see above), as well as the full cost of a rental agent or property manager.

Finally, they’re entitled to a depreciation deduction based on the 80 percent figure. If these rental expenses exceed their rental income, they would be in line for a tax loss.

But here’s the catch: Because their vacation home is used personally for the greater of 14 days or 10 percent of the number of days it is rented out, they can’t deduct a loss on their return. Keeping this in mind, they might try to stay within the boundaries of the 14-day/10 percent rule. Typically, they’d cut back their personal use or rent out the place longer, or a combination of the two.

Saving grace: Any day spent fixing up the place doesn’t count as a personal use day even if the rest of the family tags along. For example, if they fix a busted screen door while their kids are frolicking at the beach, it’s still treated as a business use day.

Even so, clients are not quite out of the woods yet. Under a special tax code provision, a vacation home rental is treated a “passive activity.” Generally, they can’t claim a passive activity loss (PAL) anyway, although there’s a limited exception based on adjusted gross income (AGI).

How it works: If their AGI is less than $100,000 and they “actively participate”” in the activity, they can use up to $25,000 of the vacation home rental loss to offset other income. The write-off is phased out and disappears completely if AGI exceeds $150,000. Any disallowed PAL is suspended and may be used in the future. For these purposes, an active participant is someone who is involved in management decisions, sets rental rates, arranges repairs and so on.

In summary: These tax rules are complex so consult with your vacation home-owning clients sooner than later for guidance.

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