You want to learn the vacation home rental tax rules if you rent, own or are considering renting or owning a second home.
Here’s why: Vacation home rentals present some tax traps for unwary owners. Some big ones.
But learn where the traps are? And how they hurt you? You can limit the damage. In same cases, you can even avoid getting blindsided or beat up. This article reviews the rules.
The General Vacation Home Rental Tax Rule: Proportional Allocations
A chunk of tax law called Section 280A describes the basic rule regarding accounting for vacation homes.
You need to calculate the percent of rental use. And then you can write off that percentage of the expenses but no more than the rental income you earned.
This sounds complicated. But in practice? Pretty easy. An example illustrates.
You personally used a vacation home for 25 days. You rented the home for 75 days.
The rental use equals 75 percent of the overall use. Therefore, you can write off up to 75 percent of the expenses.
If your expenses ran $40,000, for example, you can write off as much as $30,000 of expense.
But the rub: You can’t write off more expense that you earned in rent.
If your rental income equals $40,000, for example, you get to write off the $30,000.
But if your rental income equaled $20,000? You can only write off $20,000. Because the last $10,000 of expenses? Disallowed.
One bright spot here: Disallowed vacation home expenses—like the $10,000 in the previous example–carry over into future years and may be used then to shelter rental income. Potentially. (You’re subject to the same income limitation.)
Anyway, that’s the usual rule. And the main thing to note: You can subsidize the costs of a vacation home by renting. But you can’t generate tax deductible losses.
The De Minimis Vacation Home Rental Tax Rule
A variety of exceptions to the general vacation home rental rule of Section 280A exist.
One is sometimes called the Augusta rule because homeowners in Augusta Georgia, rumor says, make heavy use of it.
Note: The real name of this exclusion is the Section 280A(g) exclusion, which you’ll want to know for a reason I’ll explain in a minute.
If a homeowner rents her or his home for fourteen days or less and uses it as a residence for more than fourteen days? The homeowner can exclude the income.
Note that the homeowner doesn’t get to deduct expenses. But the homeowner enjoys tax free income.
Another example illustrates.
You own a home in Augusta Georgia. During the Masters Tournament, you can rent your home for $25,000 a week. Due the crazy crowds, you leave home during the tournament and rent your home for two weeks for $50,000. That $50,000? Tax-free income because you rent for fourteen days or less and because you use the home the rest of the home (so more than fourteen days.)
Note: You technically shouldn’t have to report the $50,000 of income on your tax return. But because the payor probably will report the income to the Internal Revenue Service? You’ll possibly want to show the income on a Schedule C or Schedule E form. show the Section 280A(g) exclusion as a reduction in that income, and then explicitly calculate the resulting taxable income as “zero.”
Minimal Personal Use Dodges Loss Limitation
Another common scenario with vacation rentals. When your personal use is very minimal.
When personal use is minimal? You also allocate expenses between personal use and business use. But Section 280A doesn’t prevent you from deducting a loss on the rental.
And what level of personal use counts as so minimal it doesn’t trigger the limitation? You need to use property for the lessor of fourteen days or ten percent of the days rented.
Another illustration to show the accounting.
Suppose you used a vacation property for ten days and rented it for one hundred days. In this case, because your personal use days are not more than ten percent of the one hundred rented days? And also not more than fourteen days? You allocate. But you don’t limit.
To be extreme, say you incur $110,000 of expenses. With ten personal use days and one hundred rented days, you treat $10,000 of the expenses as personal expenses and $100,000 of the expenses as business expenses.
And the kicker: Because the personal use was so minimal? You wouldn’t get limited to the income. If the rental income equals $40,000 for example? You would still get to deduct $100,000 of expenses. The loss on the property would the be $60,000 (Because $40,000 minus $100,000 equals minus $60,000.) And you’d get to deduct that $60,000 at some point during your ownership of the property.
Note: When you can deduct the $60,000 of losses would depend on Section 469 of the Internal Revenue Code. In another blog post, we describe how and when you can deduct these sorts of passive losses.
Counting Personal Days Trickier Than You’d Guess
A sidebar: You need to be careful about counting days as personal days. Or as rented days. The Section 280A chunk of law makes it easy to lose vacation home rental tax savings.
A day spent on maintenance, as long as an adult in the family, works fulltime? That day does not count as personal day. Even if the rest of the family is lounging around. This loophole, by the way, specifically applies to days spend on repairs and maintenance. To be safe, don’t assume you can use a property for some other business-y purpose and call the day a non-personal day. You can’t.
Another related wrinkle: Any day you rent a property to someone at below market value? That automatically counts as a personal day. Sorry.
Yet another wrinkle: Any day you rent to a family member counts as a personal except when you rent at a fair market rate to a family member for use as primary residence.
Finally, a last giant wrinkle to know about. Personal use of a principal residence doesn’t count as personal use days when those days fall before or after a qualified rental period.
And what the heck is a “qualified rental period?” Quoting from the law, it’s a “consecutive period of 12 months or more” for which the property is “rented or held for rental at fair market value.” Or it’s a “consecutive period less than 12 months” for which the property is “rented or held for rental” and “at the end of which such dwelling unit is sold or exchanged.”
The takeaway here: If you rent your former principal residence for at least twelve months to someone? Or you rent your former personal residence to someone (like maybe the buyer?) who occupies your home after the point you move and before you sell it? Your occupancy doesn’t count as personal days. Which means you don’t get entangled in Section 280A.
And the big planning point: You want to minimize your personal days. (Ideally, you want to so minimize your personal days that you don’t see your deductions limited to your rental income.) And if you can, you want to jack up the rental use percentage by having lots of rented days. That way you write off more of your expenses.
Other Vacation Home Rental Tax Resources
The Internal Revenue Service provides a very useful publication you want to read if you own and may rent a second home: Renting Residential and Vacation Property Note that you use some special accounting rules to pick which expenses get deducted when you report your vacation home rental income and deductions. The publication describes these.
We’ve got another copy of blog posts that talk about how to work the short-term rental tax planning opportunity: Tax Strategy Tuesday: Vacation Rental Property and Surviving Short-term Rental Audits.