Ask Carrie: Renting out your vacation home—what are the tax rules?

Dear Reader,

This is a really timely question. Renting vacation homes, or even a part of your primary residence, is becoming more common thanks to a variety of online sites that make it easy to market property and attract renters.

The pluses are obvious. Not only can a vacation home provide you and your family with precious R & R, it can also be a source of income. On the flip side, though, the tax rules for renting out your home are quite complex.

That’s not to say you shouldn’t do it. It just means you need to be aware of the rules and keep accurate records. I can give you some basics, but you might also want to consult IRS Publication 527, which spells everything out in detail.

The amount of time you rent out your home

Rental income in general is taxable. But if you rent your second home for 14 days or fewer in a year, your rental income is tax-free. You don’t even have to report it on your tax return—no matter how much it is.

If you go past the 14-day limit, you have to report your rental income and pay taxes on it. You can deduct rental expenses, but here’s where it starts to get complicated—because the amount of expenses you can deduct depends on whether the property is a business or a personal residence in the eyes of the IRS. And that depends on the proportion of personal use to the amount of time you rent the property.

Once again, 14 days comes into play. If you use your vacation home for 14 days or fewer in a year or less than 10 percent of the days it’s rented, it’s considered a business. If you use it for more than 14 days or more than 10 percent of the days it’s rented, it’s considered a personal residence.

So let’s say you decide to spend the month of June (30 days) at your vacation home. You’ve passed the 14-day limit. Even if you rent it out for 90 days or 190 days over the course of the year, it’s still considered a personal residence.

What constitutes personal use

To make things even more confusing, the definition of personal use includes not only your own use but also use by family members, days you may have donated the use of the house, or days that you rent it out for less than fair market value.

So if you give your out-of-town relatives a generous break on the rent or you donate two weeks to a local charity auction, that time would be considered personal use.

On the other hand, the days you spend at the house doing maintenance don’t count. If you spend a weekend, a week, or even a month fixing up the property, that time is off the books.

Expenses that can be deducted

The reason all this is important goes back to taxes. If the property is considered a personal residence, you can deduct things like mortgage interest and property taxes. But when it comes to other expenses, you have to apportion eligible deductible expenses (i.e., cleaning, repairs, utilities) according to the amount of personal or rental usage.

To determine the percentage of expenses you can deduct, divide the number of days rented by the total number of days of usage (personal days plus rental days). So if you use the house for 30 days and rent it for 90 days, you could deduct 75 percent of eligible expenses (90 divided by 120).

If you limit your personal use to 14 days or 10%, the property is considered a business. Not only can you deduct all eligible expenses, you might be able to deduct losses up to $25,000 in the current or future tax years. You can also write off depreciation.

State tax concerns

For the record, state and local laws vary on collecting sales taxes or hotel taxes, even on short-term rentals. So you’ll need to look into your state’s requirements.

There’s a lot to think about, but don’t let it spoil your fun. Just make sure to talk to your tax advisor and keep good records. Then, hopefully, you can sit back and relax.