If you own a vacation home that you’re thinking about renting out, do some tax planning first.
Your home will be considered investment property if you limit your personal use of the home to no more than 14 days a year or, if greater, 10% of the total number of days it is rented out. The tax result: Expenses associated with renting the property, such as utilities and maintenance, generally will be tax deductible in full (but see notation below* regarding the tax law’s passive activity rules). Exceed the 14 days/10%-of-rental-days threshold and your tax deductions for rental expenses generally will be limited to the amount of rental income you collect.
What counts as a day of personal use? Generally, you must count any day you occupy the home. But you may exclude days you spend fixing up the home in preparation for renting it, if that is your primary purpose for being there. Also note that you must count days you allow family members to use the home as personal use days.
Your days of personal use won’t be important if you rent your vacation home for less than 15 days a year. Why? The tax law gives you a special break in this situation: You don’t have to report any of your rental income (nor can you deduct rental expenses, other than property taxes and qualifying mortgage interest). Thus, the income you collect will be tax free.
This special tax break isn’t limited to vacation homes. It is also possible to lease your primary residence for two weeks or less and enjoy the rental income free of tax.
Reach out to your financial professional if you have additional questions regarding tax planning.
* In general, losses from renting real estate may be used only to offset income from other “passive activities,” not ordinary income like wages and interest. However, if you actively participate in managing your property, you are allowed to deduct up to $25,000 of rental losses against ordinary income (subject to an income-based phaseout).