What are the Tax Rules for Vacation Rental Property?

Tax 101

It’s summer time and your vacation home has been spruced up for the onslaught of travelers. Maybe you rent out your vacation home throughout the whole year or perhaps you rent it out only a few times—there’s no right or wrong scheduling option so long as you adhere to the vacation rental tax rules as prescribed by the Internal Revenue Service.

The short-term rental market is booming and shows no signs of slowing it’s rapid-fire growth, and with the rising popularity of Airbnb, VRBO, HomeAway, and other vacation rental platforms, it’s important for renters to understand their tax responsibilities before venturing into this lucrative extra income avenue. To best prepare you for your financial liabilities come tax season, we’re here to dissect and dive into the vacation rental tax rules you need to know.

Home Used Mostly By Owner

Despite their strict nature, the vast majority of tax laws are full of exceptions. For those renting out a vacation home rental, it’s important to familiarize yourself with the 14-day rule. Also known as the Master’s exception, the 14-day rule states that if you only rent out the house for 14 days or less, it is considered your personal residence and you are not required to report income.

With this amount of time, you can’t deduct expenses associated with the home, however, you can claim typical homeowner deductions for the following:

  • Mortgage interest
  • Real-estate taxes
  • Casualty losses

Once you’ve crossed the 14-day threshold, you will become subject to a multitude of new tax obligations that will likely complicate your filing. In the event that you receive a letter from the IRS because your choice rental marketplace platform reported the income earned to the government, don’t panic! All you’ll need to do is prove that the income qualifies under the 14-day exception and you’ll be in good legal standing.

Mixed-Use by Owner and Tenant

If you rent your home out for more than 14 days a year, you will be considered as the landlord of the property in the eyes of the IRS, and will be required to report rental income on Schedule E. This means that you can now deduct expenses, however, you will be obligated to prorate them. Be careful in your calculations, as some limitations do apply.

How to prorate: To calculate your proration rate, divide the number of days you rented out your home by the total number of days the space was used for both personal and business purposes.

If the home is considered a residence, the deducted expenses cannot be greater than the rental income. Alternatively, if the home is not a residence, the expenses deducted can be more than the rental income. Your loss is limited by the passive-activity rules.

  • The home must provide basic living accommodations, including a sleeping space, bathroom facilities, and cooking facilities. A residence might be one of the following:
    • House
    • Condominium
    • Apartment
    • Mobile home
    • Motor home
    • Houseboat
  • The home must also pass the personal-use time test. Your home is considered a residence if you use it for personal purposes for more than:
    • 14 days per year
    • 10% of the total number of days you rent the home at fair rental value

For Personal Use

The definition of “personal use” can be a bit confusing to decipher, but in this case, it typically includes any days you or a family member used the house (even in the case that the family member is paying rent). Personal use days also include days on which you are allowing others to use the house free of charge or have rented it out for less than fair market value.

For Business

If your personal use days are less than 14 days or 10% of the time the vacation is rented, then the property will be considered a business. Depending on your income, you are able to deduct expenses and may be able to deduct up to $25,000 in losses each year. For this reason, many vacation homeowners do not use their own properties for leisure and instead spend more time “maintaining” the property – days used to work on the house do not count as personal use.

State Taxes and Local Laws

Another key legal consideration renters should be aware of is that laws and tax rules for vacation rental property vary from state to state. Some states collect sales tax, whereas others impose hotel taxes, and it’s important to know where your state lies on the spectrum.

Check out your state and local government laws and requirements before tax season rolls around to make sure you have a comprehensive look at your expected liability. Get educated on any local laws regarding permitting and any HOA rules before plunging into the rental property game—at the end of the day, you want to make sure everything your doing is in perfect alignment with local and federal laws, so it’s well worth your while to do your research well before renting out.

What to Do for Tax Season

When tax season finally rears its head, and you’ve surpassed the 14-day non-reporting range, your reporting responsibilities will change. As mentioned before, you will be required to file Schedule E alongside your income tax return, so you should make a pointed effort to keep organized records of all your tax related documents.

Following these six steps, we’ll walk you through how to file your vacation rental property tax form:

Step 1: Report 100% of rental income earned on Schedule E of Form 1040

Step 2: Deduct 100% of any direct rental expenses (these include costs ranging from maintenance fees to management fees)

Step 3: Divide mortgage interest and property tax costs between rental and personal use

Step 4: Deduct any Schedule E rental expenses from Step 3

Step 5: If you have any remaining net rental income after completing Step 4, you will be able to deduct indirect expenses (i.e. utilities, depreciation, maintenance, insurance, etc.)

Step 6: List your qualifying deductions on Schedule A of Form 1040

Conclusion

There is no denying that the many vacation rental tax rules and laws renters are expected to follow can be confusing without some extra clarification. Rest assured knowing that even if you’re left scratching your head, outsourcing the heavy lifting to a tax professional can streamline the entire process completely error-free. At CommunityTax, our seasoned experts are trained to help you understand all of the nitty-gritty vacation home rental tax rules and make your tax season completely painless.