My wife and I recently spent a week at Bass Lake near Yosemite in California. The weather was perfect and the lake was a beautiful place to get away from daily responsibilities. While there, it was impossible not to wonder about buying a vacation lake home to come back to anytime. We could rent it to other vacationers and make it an investment, maybe it would pay for itself?
If you have ever thought about purchasing a vacation home to also rent, you must learn how the IRS treats the income and expenses for the home. These special vacation home rental rules apply to:
- A vacation home that is rented and used personally.
- A bedroom or a portion of a home that is rented and used personally.
The first thing to learn is how the IRS defines Personal Use.
Personal Use of a Property
Generally, expenses related to Personal Use are not deductible. However, income received for Personal Use is taxable. If you own a home, you probably know that most expenses are not deductible on your tax return. Only your mortgage interest and property taxes are deductible. This concept also applies when you rent your home part-time and live in it part-time.
Rent or use by relatives
Personal use includes more than meets the eye. The IRS Personal Use definition includes rent to or allows use by a relative. Even if you charge fair market rent (i.e., the same rate you would charge a non-relative), the expense related to personal use is not deductible.
Paying and non-paying relatives who use your vacation home complicate your deductions. Such use by your relatives is personal use by you. Relatives include:
- mom and dad,
- brothers and sisters (whole and half),
- sons and daughters,
- grandchildren and grandparents,
- spouse and possibly ex-spouse.
Planning tip. Do not rent to relatives. If you do, remember the income and expenses are treated just as if you were living in the home.
Co-owners
Co-owners must count both use by their relatives and use by themselves as Personal Use. If you own a rental home with others, make sure you know about the personal use of each co-owner and also use by their relatives.
Charitable Donations
Charitable donations are personal use. No matter how much the donor pays for the use of your home, the IRS counts the donor’s use as personal use by you.
If you donate a week at your vacation home to your school’s annual auction, you have a week of personal use. It makes no difference what the successful bidder pays for that week.
Your charitable gift of the right to use your home for the week does not create a deductible contribution for you. IRS regulations deny a charitable contribution deduction for a gift of the right to use a property.
Planning tip. This charitable gift of your home penalizes you twice. First, the days you donate are days of personal use by you. Second, your donation of the days does not create a charitable deduction for you. Consider making a cash donation instead.
Swaps
Swaps are personal use. Similarly, you have personal use when you swap properties with a friend or under an exchange agreement. Swaps and bargains (i.e., reduced rent) create personal days. You count as personal use of your home any days that you:
- Allow a person to use your unit under an agreement that lets you use another property, whether or not you charge rent; or
- Charge less than fair market rent.
Example 1. You and Katie swap one week of vacation home use. Katie’s use of your property during the one-week swap counts as personal use by you.
Example 2. You and Tom rent each other’s mountain homes for a week at fair market rent. Tom’s rental of your property during that one week counts as personal use by you.
Example 3. You charge your child’s favorite teacher 67 percent of the fair rent to use your beach house for a week, the teacher’s use of the beach house counts as personal use by you.
Repair Days
Repair days are not personal use. Tax law says that you do not use your vacation home on days when your principal purpose for such use is repair or maintenance. To qualify the day as a repair day, you must work substantially full-time repairing or maintaining the home.
Example 4. You and your spouse arrive Thursday evening at your lakeside cottage after a long drive, but in time for a late dinner at the cottage. You spend a normal workday on both Friday and Saturday getting the unit ready for rental. Your spouse does no work on the house and relaxes at the beach.
You depart Sunday, a little before noon. According to the IRS’s examples, the principal purpose for the trip is maintenance. You do not count Thursday, Friday, Saturday, or Sunday as days of personal use. The repair days are non-use days.
Example 5. You own a mountain cabin that you rent in the summers. You spend a week at the cabin with your family. The family members work substantially full time repairing the cabin. You spend about three to four hours each day during that week helping, and the rest of the time fishing, hiking, and relaxing. According to the IRS, your family’s principal purpose of that week’s stay is maintenance; therefore, the days are not days of personal use.
Rented Fewer Than 15 Days
If you rent your home for fewer than 15 days, you do not report the rental income or any rental expenses on your tax return. The income is tax-free.
Planning tip. Do you have an event coming to your area that might command high rents? Examples include a major golf tournament, Super Bowl, Olympic event, or other activities that could allow you to rent your home at a high rate for a short period.
Example 6. You have a summer condo on the beach next to a major golf tournament. You rent your condo for $10,000 a week for two weeks. You have $20,000 of tax-free income.
Personal Residence or Investment Rental?
The amount of personal use determines how you will treat your tax deductions on the property. You have a tax code-defined home rental when your personal use is the greater of either
- 14 days or less, or
- 10 percent or less of the days rented.
Example 7 – Investment rental. You rent your resort home for 260 days. You use it personally for 26 days. (The other 26 days were non-use days—the property was vacant.) Ten percent of your resort home is personal use. Ninety percent is a rental property. The Investment Rental Rules apply.
Example 8 – Residence rental. With 30 days of personal use of the resort home in example 7, you have a residence. Residence income and expense rules apply. Your deductions on the rental part during the current tax year may not exceed your rental income (i.e., you cannot deduct the loss on your tax return).
Excess deductions carried forward. When the law deems your property a residence, the deductions attributable to the rental are limited to gross rental income. The good news is that you carry forward the deductions above the income limit to next year (i.e., the loss carries forward to the next year and can be used to offset income in that year).
Treatment as an Investment Rental Property
If based on your rental and personal use, tax law classes your summer home as an investment rental property, you should follow the IRS allocation method to get the best tax breaks. These rules generally allow you to take a percentage of the expenses as a deduction on your tax return.
The personal part of interest lost. If tax law classes your home as an investment rental property, any mortgage interest allocated to your personal use is non-deductible consumer interest.
Passive loss rules. A home classified as a rental property faces the passive loss rules, which usually means that losses can only offset passive income (e.g., other investment income, interest, and gains.)
Record Keeping is Important
As with any rental property, keeping records of time spent at the vacation home for personal use and maintenance is essential. There should be records of all income received and expenses paid. If you pay independent contractors more than $600 for repairs, you may be required to issue 1099’s to them.