Reader Mail: Rental Property or Vacation Home?


The approaching year end always brings up interesting (and relevant) tax questions from my coaching clients and readers.  I found this in my inbox this week, and it's such a good question I thought I'd share…

Reader asks:

Hi Bill:  I have a question about my vacation property.  I rented the property during the off season, but my family and I used it some during the year.  Can I deduct any of the expenses like the mortgage and utilities?  Thanks for your help.

And Bill responds:

So, we know that if you rent out your property and never use it personally, it is considered rental property, and all the usual deductions are available to you.  This includes depreciation, mortgage interest, repairs and maintenance, and property taxes to name just a few.  These deductions would properly be reported on Schedule E of your Federal Form 1040.

If you never rent out your property, it is treated as a second home. As with your principal home, you can deduct real estate taxes and mortgage interest, subject to any limitations such as the alternative minimum tax.  These deductions would appear on Schedule A of your personal 1040.

The complications (and fun for us tax geeks) come when there's a mix of personal and rental use.  According to the tax laws, your use of the second home is “personal” if on any day (or part of a day) it is used by:

• You or any other person who has an interest in it, unless you rent your interest to another owner as his or her main home under a shared equity financing agreement
• A member of your family or of a family of any other person who has an interest in it, unless the family member uses it as his or her main home and pays a fair rental price
• Anyone under an agreement that lets you use some other dwelling unit
• Anyone at less than fair rental price

The Internal Revenue Service treats mixed-use property either primarily as a home or primarily as a rental, and the tax treatment for each differs.  Not only that, the designation can change from year to year.  Good times!!

Primarily as a Home

Your second property will be treated primarily as a home if your days of personal use exceed the greater of:

14 days, or

10 percent of the total number of days the property was rented out to others at a fair rental price.

If classified as a home and you rented it out for fewer than 15 days during any one year, any income you receive is yours to keep and need not be reported on your tax return as income. However, you cannot deduct any rental expenses.  (Think two weeks of tax free income!!)

That being said, if the property qualifies as a home (because of the amount of personal use) and you also rent it out for more than 14 days,  you must declare your rental income. You can deduct your rental expenses, but only up to the amount of the rent you received. You also must divide your expenses between personal and rental use based on the number of days of each.

According to the IRS:

If you had a net profit from the rental property for the year (that is, if your rental income is more than the total of your rental expenses, including depreciation), deduct all of your rental expenses. However, if you had a net loss, your deduction for certain rental expenses is  limited.

If your rental expenses are more than your rental income, you cannot use the excess expenses to offset income from other sources. The excess can be carried forward to the next year and treated as rental expenses for the same property.

Deductions can include management fees and advertising costs. Additionally, items such as insurance, repairs, utilities and depreciation — which you cannot deduct for a principal home — can now be deducted, although on a pro rata basis, depending on the ratio of personal to rental use.

The tax code requires that you deduct your expenses in a particular order. Mortgage interest and real estate taxes applicable to the rental period are deducted first and are put on Schedule E of your income tax return. All the other expenses associated with the rental property are also allocated but put on Schedule A of your tax return.

Primarily as a rental

If you do not use your property enough for it to be treated as a home, then it is a rental property. The income you receive must be reported. But now you can deduct all of your rental expenses, even though they may exceed the amount of your rental income, subject to passive loss limitations.

With proper tax planning and documentation, you can take a two-week vacation at your beach house and still treat it as rental property.  Sweet!!

Thanks for a great question!

As always, thanks for reading…and leave your comments or questions below.