03/10/2010
My friend Lee, a sports fanatic, traveled with a gang of his golfing buddies to the Masters’ in Augusta, Georgia. They rented a suite of rooms in a private home in the tony country club community and lived like rich guys for a week. It cost a fortune, but all agreed that it was worth every precious penny. Lee reported that the rent probably covered a couple of months of the homeowner’s mortgage.
Sweet deal for the homeowner, he said.
Even sweeter – because the income was NOT taxable to the homeowner under vacation rental rules.
What???? Tax FREE income???? Yes…but…there are some twists and turns that could be unpleasant if you are not aware of the rules.
Let’s start with a definition. What is a vacation rental? It could be a condo on the north shore of Kauai, a chalet in Squaw Valley, a sailboat that sleeps ten, a casita in Santa Fe, or the basement of your house in Augusta, Georgia. In other words, it is simply a rental property. It could be rented out to the same person for months at a time or different people every week or available only a few weeks of the year because you and your family use it (or want access to it) the rest of the time.
If you use the property as a personal residence, AND you rent it out occasionally, it will probably be subject to the rules for Personal Use of a Dwelling Unit, AKA a mixed-use property. Lots of detailed information can be found in IRS Publication 527 http://www.irs.gov/pub/irs-pdf/p527.pdf.
Here is the skinny on property you use part of the time and rent out part of the time:
RENTED 14 DAYS OR LESS DURING A YEAR: If you use the property more than 14 days in a year, and rent it out 14 days or less in a year, you can charge whatever you want, whatever the market will bear, and you do not have to claim any income. Nada. You don’t get to deduct expenses other than perhaps mortgage interest and property taxes, just as you normally would. The IRS says that this is simply your personal residence.
RENTED A LOT, YOU USE IT VERY LITTLE: If you use the property no more than 14 days a year (or 10% of the number of days rented at fair value), the IRS deems that the property is a true rental. You claim the income on Schedule E (rental property) and divide up the expenses between personal use and rental use. The BAD kicker here is that the personal use allocation of mortgage interest is not deductible. You may get to take a deduction for all of the property tax, as well as for expenses directly related to the rental period. You may be able to take a loss on the property, including a deduction for depreciation.
YOU USE IT A LOT AND IT IS RENTED OCCASIONALLY, BUT MORE THAN 14 DAYS: In this case, you claim the income on Schedule E. You can deduct the mortgage interest related to the rental period and IF this is your second home, you can deduct the balance of interest as an itemized deduction. Same with property tax. Expenses incurred during the rental periods are fully deductible, but only to offset income. You cannot take a loss. Expenses related to personal use of the property are not deductible.
If you spend a day cleaning or maintaining the property, that day is not counted as a personal use day. However, if any family member, friend or charitable organization (ie you made a donation of a week’s stay for an auction) is using the property and paying less than fair market rental, those days are considered personal days.
After wading through all of the above, you probably need a vacation. But be sure to talk with us before adding a mixed-use vacation rental to your portfolio – you need to know ahead of time how it will impact your tax return. After all, you want a vacation, not an taxing adventure, right?