Tax Edge

By Toolkit Staff

With summer almost here, vacation plans are taking up most of our mental energy. As hard as it may be to shift the focus, this is a perfect time to consider the tax breaks associated with vacation home rentals.

If you are fortunate enough to have a vacation home, whether it's a family cottage in the country, a condo in the city, or a houseboat on the lake, you may be able to take advantage of it for more than just your own summer vacations. Such properties can be rented out, even if only for a few days or weeks each year, so that they at least partially pay for themselves. And you may be able to earn this rental income tax-free.

The IRS basically uses a two-week de minimus rule in determining whether to tax rental income. If you rent out a vacation home for two weeks or less during the year, you don't have to report any rental income you receive. However, you also can't deduct any related rental expenses you have (except for the normal home mortgage interest and real estate tax deductions you would have anyway). In short, the IRS will ignore rental activity of 14 days or less.

If you have property that is rented out for more than 14 days during the year, and you or your family, or any co-owner or his or her family, use it for personal purposes for even one day of the year, you have to divide all the expenses of the property into two buckets: "personal" and "rental."

The rental expenses will generally be deductible on Schedule E, Supplemental Income and Loss, and the personal expenses will not be deductible except for mortgage interest, real estate taxes, and casualty losses that you could ordinarily claim on Schedule A.

On Schedule E you can deduct the entire amount of expenses that apply only to renting, such as advertising, commissions, credit checks, etc. For all expenses that apply to the entire home, such as mortgage interest, real estate taxes, insurance, utilities, and repairs and maintenance on the furnace, roof, electric system, etc., you must generally divide the expenses on the basis of days spent for personal use, compared to days that the property was rented at a fair market rate; the total need not add up to 365 days.

When counting days of "personal use," you must include any days that you donated the use of your property to a charitable organization (for example, if you allowed a charity to auction off a week in your lakefront house). Also count as "personal" any days that you traded with someone else for the use of a different property, or any days for which you charged less than fair market rent. However, don't count as "personal" the days you stayed in the home because you were having repairs or maintenance done, even if your family stayed with you.

Substantial personal use of the vacation home. More restrictive rules apply if you or your family, or any co-owners or their families, use the rental property for personal purposes for more than the greater of 14 days or 10 percent of the days it is rented out to others.

In that case, not only do you have to apportion your expenses between the "rental" and the "personal" use, but if rental expenses exceed rental income for this mixed-use property, you can only deduct the expenses to the extent of the rental income. You can't show a loss from the property for tax purposes. However, any excess expenses can be carried over and deducted in the next year.

This additional restriction doesn't apply if you converted rental property to a personal residence during the year. You also don't have to apply it if you converted a personal residence to a rental during the year and you rented or tried to rent it out for at least 12 months, or if you would have rented it for at least 12 months except that you sold or exchanged the property before the 12 months were up.

Hopefully these tips can help you earn some extra tax-free income in the months to come. Now, have a great summer!

Posted June 25, 2009.