Some people have vacation homes. Others have rental properties. Still others have both. Yet sometimes you find yourself owning a property which you use personally, as well as rent out to others. This type of setup can have obvious benefits. Very few individuals utilize their vacation homes year-round. Some don’t utilize them at all for long stretches of time. Vacation homes often go vacant even during their peak season.
So why not generate some income from an asset that is otherwise just sitting there? Now granted, some people just do not want anyone else living in their home for various reasons. But others don’t mind and prefer to generate some extra income. But renting a property that you also use personally can create some potentially complicated tax issues.
There are several different scenarios which require different tax treatment when renting a property (or dwelling unit) such as a vacation home. Knowing some of the basics can help you plan more effectively. But before we proceed, how about some of the basics.
Property Used Only For Personal Purposes
A property used for personal purposes only may include your main residence, or a vacation home. With such properties, you can deduct mortgage interest and property taxes on Schedule A (itemized deductions) of your tax return.
Property Used Only for Rental Purposes
A rental property may be a single family home, duplex, etc. which you rent out in order to generate a profit. Any rental income received is reported on your tax return via Schedule E (Supplemental Income and Loss). Deductible expenses incurred in generating the income are also reported on this same schedule. Such expenses may include mortgage interest, property taxes, insurance, utilities, commissions, supplies, maintenance, and repairs.
Property Rented Out to Others and Also Used Personally
However, when you own a property for personal use and also rent it to others, different rules apply. So lets take a look…
Property rented less than 15 days during the year
If you rent the property for less than 15 days during the year, the property is not treated as a rental property at all. It is treated as personal use property only. As such, you are not required to report the rental income and rental expenses from this property. Any rental income received is not taxable, and expenses such as mortgage interest and property taxes will be reported on Schedule A as itemized deductions. So renting a property for less than 15 days per year can net you some tax free income! Nice deal. But if you rent it for 15 days or more…
Property rented 15 or more days during the year, but no personal use
If a property is rented for 15 or more days during the year, and there is no personal use during the year, the rental income and related rental expenses are reported on Schedule E. The property is treated as a pure rental. But when you have a personal use above a specific amount and also rent the property at least 15 days, things can get complicated.
Property rented 15 or more days during the year, and personal use is less than the greater of 15 days or 10% of days rented to others at a fair rental price (not used as a home)
When a property is rented 15 or more days and personal use is less than 15 days or 10% of the days rented to others at a fair rental price, the property is not considered used as a home. In such a case, you must split your expenses between rental use and personal use. The allocation is made based on the number of days used for each purpose.
For purposes of allocating expenses between personal and rental use, any day the property is available for rent but not actually rented is not a day of rental use. Also, any day the property is rented at a fair rental price is a day of rental use even if you used it for personal purposes that day.
The expenses allocated to rental use may be used to offset rental income on schedule E, and are only limited by the passive activity and at-risk rules. As such, it is possible to deduct more than your income and create a loss. The personal use portion of expenses such as property taxes and interest are reported on Schedule A as itemized deductions to the extent they would otherwise be deductible.
Property rented 15 or more days during the year, and personal use is more than the greater of 14 days or 10% of days rented to others at a fair rental price (used as a home)
When a property is rented 15 or more days and personal use is more than 14 days or 10% of the days rented to others at a fair rental price, the property is considered used as a home. This is the least desirable scenario. If the property is considered a home, the amount of the rental portion of the expenses you can deduct may be limited.
Once the expenses are divided between personal use and rental use (as described above), the personal use portion of otherwise deductible expenses may be claimed on Schedule A (same as above). Next, the rental use portion of property taxes and mortgage interest are applied against the rental income. Expenses directly related to the rental activity, and not the use of the home may also be deducted. This may include expenses such as rental agency fees, advertising, office supplies, and depreciation on office equipment used in the rental activity. These expenses may create a rental loss subject to the passive activity and at-risk limitations.
Expense Deductions May Be Limited
However, if there is income remaining after these expenses, it may be offset first by any other rental use expenses (such as repairs, utilities, etc.), and then depreciation on the real property, in that order. However, these expenses cannot create a loss. Any excess expenses are carried forward to the next year and treated as rental expenses for the same property. Expenses carried forward to the next year will be subject to any limits that apply for that year.
This limitation (to the extent of rental income) will apply to expenses carried forward to another year even if you do not use the property as your home for that subsequent year.
To the extent there is no income remaining after the property tax and mortgage interest deductions are applied, the remaining rental use portion of the expenses is carried forward to next year.
Things to Keep in Mind When Determining if You Use the Property as a Home
Following are some tips to keep in mind when determining if a property is used as a home:
Day Rented and Also Used Personally
If the property is used for personal purposes on a day it is rented at a fair rental price, do not count the day as a day of rental use for purposes of determining if the property is used as a home. This is the opposite to the rule above used in determining the allocation of expenses between rental and personal use.
Days Working Full-Time on Repairs and Maintenance of the Property
Any days spent working substantially full time repairing and maintaining (not improving) your property are not counted as days of personal use even if the property is also used for recreational purposes by family members.
Days Used as Main Home Do Not Count As Personal Days
Also, in determining if the unit was used as a home, do not count days for personal use if you used the property as your main home before or after renting it (or offering it for rent). This rule only applies if you rented (or tried to rent) the property for 12 or more consecutive months. It also applies if you rented (or tried to rent) the property for less than twelve consecutive months due to a sale or exchange of the property.
Keep in mind, however, that this rule does not apply when counting days for purposes of dividing expenses between rental and personal use.
Main home is generally defined as the one lived in most of the time.
Which Individuals’ Use Of The Property Can Qualify As Personal Use?
A day of personal use for purposes of determining if the property is used as a home is any day it is used by any of the following persons:
- You or any other person who has an ownership interest in the property
- A member of your family or a member of the family of any other person who owns an interest in the property. There is no personal use if the family member uses the unit as his or her “main home” and pays a fair rental price. Family for this purpose includes your spouse, siblings, ancestors, and lineal descendants.
- Anyone who rents the property at less than a fair rental price.
- Anyone under an arrangement that lets you use another dwelling unit.
As you can see, the rules are a bit complex. But a basic understanding may save you money if you rent out your vacation home, for example. Keeping track of personal use and rental use days will allow you to plan accordingly. You may be able to qualify for some tax-free income. At the very least, you should try to avoid the “used as a home” tag which can limit your expense deductions.
For more information and examples on this topic, you can read IRS publication 527.
Click here for more tax related articles.