Planning to Rent Out Your Vacation Home? Understand the Tax Rules.
Rental services like Airbnb and VRBO can make renting a vacation home seem easy. But the tax rules are still complicated.
How you're taxed and what expenses you can deduct depend on the amount of time you use the property yourself.
Don't be discouraged by the rules—just be prepared.
My husband and I own a small vacation home. Now that summer's over and it's so easy to rent through sites like Airbnb or VRBO, we figure it only makes sense to rent it for part of the year. What does this mean for taxes? —A Reader
Great idea—and great question. More and more people are taking advantage of the relative ease of renting through online rental services, whether a vacation home or a part of their own house. I've heard it described as "found money." However, while the extra income can be a real boost, the tax rules can be mind-numbingly complex. That doesn't mean you shouldn't give it a try. It just means you need to be aware of the rules before you start the process so you know what you're getting into.
I can give you some basics, but I urge you to talk to your tax advisor so you understand how the rules apply to your situation. You might also want to consult IRS Publication 527, which spells everything out in detail. That said, here are some of the key points to consider.
The amount of time you rent out your home
Rental income in general is taxable. But the IRS gives you a small break if you rent your second home for 14 days or fewer in a year. In this case, your rental income is tax-free. You don't even have to report it on your tax return—no matter how much it is. Of course, this also means that you can’t deduct any of the expenses on renting the property on your tax return.
If you go past the 14-day limit, you have to report your rental income and pay taxes on it. On the plus side, 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. Here's how it works:
- Your property is considered a business 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.
- Your property is considered a personal residence if you use it for more than 14 days or more than 10 percent of the days it's rented.
So let's say you spent the month of June (30 days) at your vacation home. You've passed the 14-day limit. Even if you have the good fortune to rent it out for 90 days the rest 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 days you use the property, but also your family members; days you may have donated the use of the house; or days 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 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 do not count as personal use. 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 and expenses. If the property is considered a personal residence, you can generally itemize and deduct things like mortgage interest and property taxes. But when it comes to 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, you divide the number of days rented by the total number of days of usage (personal days plus rental days).
So let's go back to the previous example. If you used your vacation home for 30 days and rented it out for 90 days, you'd divide 90 by 120 to get 75 percent. Therefore you could deduct 75 percent of eligible expenses up to the total amount of the rental income. If your expenses exceed the rental income, you can't take a loss on a personal residence, but you may be able to carry excess expenses forward to the following year.
If you limit your personal use to 14 days or 10% of the total days you rent it out and the property is considered a business, the rules change. You may be able to deduct all eligible rental expenses and deduct losses up to $25,000 in the current or future tax years.
In addition, you can recover the cost of income-producing property by depreciating the part of the property that is used for rental purposes. Bear in mind, though, that depreciation reduces your basis for figuring gain or loss on a later sale or exchange. In other words, a lower basis will potentially subject you to higher capital gains tax when you sell the property.
State and local taxes and other rules
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 own state's and local government’s requirements. In addition, it’s prudent to check with your local authorities on permitting and HOA rules before renting out your property.
What to expect come tax time
Rental services like Airbnb generally submit a 1099 to the IRS reporting your rental income. So be sure to keep good records of your rental income as well as fees paid to the rental service and all your expenses. If you've rented out your vacation home for more than 14 days, you’d generally have to file Schedule E with your income tax return.
As I said, the rules can be complicated but don't be discouraged by the details, just be prepared. And do talk to your tax advisor to make sure you have it all under control.
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