Navigating Vacation Property Rental Tax Issues
Purchasing a vacation home and renting it when you are not using it is an excellent way to help finance the property. However, the tax aspects of renting your vacation home while also using it as a personal residence can get tricky. By involving a tax professional at the beginning of the process, you are much more likely to avoid complicated tax problems down the road.
Rental property used for personal purposes.
Special tax rules apply when you rent to the public a property that you also use as a personal residence. If you personally use a "dwelling unit" that you also rent to the public, the expenses incurred must be divided between rental use and personal use. A dwelling unit includes a house, apartment, condo, mobile home, boat, vacation home or similar property.
You are considered to have used a dwelling unit as a personal residence if your use of the property for personal purposes during the year exceeds the greater of (1) 14 days, or (2) 10% of the number of days for which the dwelling unit is rented at fair market value during the year.
For tax purposes, your rental expenses are limited to your total expenses multiplied by a fraction, the denominator of which is the total number of days the property is used, and the numerator of which is the total number of days the property is rented at a fair rental price.
A fair rental price for your property is generally the amount of rent that a person who isn't related to you would be willing to pay. The rent you charge isn't a fair rental price if it is substantially less than the rental amounts charged for other similar properties in the area. Thus, renting to family or friends at below-market rates can be a problem, as those rental days are considered personal days. Calculating rental expenses based on such days can lead to the rental expense deductions on your tax return being rejected and penalties assessed.
Calculating rental expenses.
As an example of how the above rules apply, assume you own a beach cottage in Cape May, New Jersey, and it's available for rent from June 1 through Aug. 31 (92 days). Except for the first week in August (seven days), when you were unable to find a renter, you rented the house at a fair rental price. The tenant who rented the cottage for July allowed you to use it over one weekend (two days) without any reduction in or refund of rent. Your family also used the cottage during the last two weeks of May (14 days). The cottage wasn't used at all before May 17 or after Aug. 31.
The rental expenses are calculated as follows:
(1) The cottage was used for rental a total of 85 days (92 − 7).
(2) The days it was available for rent but not rented (seven days) aren't days of rental use.
(3) The July weekend (two days) you used it is rental use because you received a fair rental price for the weekend.
(4) You used the cottage for personal purposes for 14 days (the last two weeks in May).
(5) The total use of the cottage was 99 days (14 days personal use plus 85 days rental use).
(6) Your rental expenses are 85/99 (86%) of the cottage expenses.
The personal residence determination each year is calculated as follows:
It's important to note that when determining whether you used the beach cottage as a personal residence, the two-day July weekend that you used the property is considered personal use even though you received a fair rental price for the weekend. Therefore, you had 16 days of personal use and 83 days of rental use for this purpose. Because you used the cottage for personal purposes more than 14 days and more than 10% of the days of rental use (eight days), you used it as a personal residence. Thus, if you have a net loss, you may not be able to deduct all the rental expenses.
Your rental expenses are only deductible on your Form 1040, Schedule E (Supplemental Income or Loss). However, some of your personal expenses relating to the property (such as mortgage interest or property taxes) may be deductible on Form 1040, Schedule A, if you itemize your deductions.
Special 15-Day Rule
There's a special rule if you use a dwelling unit as a personal residence and rent it for fewer than 15 days. In this case, you do not have to report any of the rental income, nor can you deduct any rental expenses.
It’s complex. Get help.
As you can see, the rules and calculations involved in determining the correct tax reporting for a vacation rental property that is also used part time as a personal residence are complex. Getting a tax professional involved in the beginning of the process will save you time and energy, not to mention penalties and additional tax assessments if the rental deductions on your tax return are incorrect.