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Some say that vacations are like love -- anticipated with pleasure, experienced with discomfort, and remembered with nostalgia. Others would say they’re two weeks on the sunny sands, with the rest of the year on the financial rocks. For those who own a vacation home, it may very well be like coming back home.
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Your vacation home can also have an impact on your taxes: it may be a means for lowering your taxable income and you’re just about to find out in what ways this can happen.
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What you need to know first of all is that, from the IRS point of view, a vacation home can be a house, an apartment, a condominium, a mobile home, or a boat, as long as there are sleeping, cooking, and bathroom facilities.
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To find out what kind of deductions you may be entitled to for your vacation home, it is very important to determine how it is used, if it’s for personal use exclusively, if you keep it as an investment for rental use alone, or if you rent it and also use it for your personal benefit.
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If you bought your vacation home exclusively for personal enjoyment, you can generally deduct your mortgage interest and real estate taxes, as you would on a primary residence, on Schedule A of your Form 1040.
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If you use a vacation home as a residence and rent it for fewer than 15 days per year, you do not have to report any of the rental income. Once again, Schedule A, Itemized Deductions, may be used to report regularly deductible personal expenses, such as qualified mortgage interest, property taxes, and casualty losses.
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If you don’t use your vacation property yourself and receive rental income for it, you may deduct certain expenses. These expenses, which may include mortgage interest, real estate taxes, casualty losses, maintenance, utilities, insurance, and depreciation, will reduce the amount of rental income that is taxed. You will generally report such income and expenses on Form 1040 and on Schedule E, just like with any other ordinary rental property.
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Without personal use, the home is considered an investment or rental property by the IRS. Time spent checking in on a house or making repairs doesn’t count as personal use.
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In this case, your deductible rental expenses may be more than your gross rental income. Your rental losses, however, generally will be limited by the "at-risk" rules and/or the passive activity loss rules.
Different rules apply if you use a vacation home as your residence and also rent it to others.
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| It is possible that you will use more than one dwelling unit as a personal residence during the year. For example, if you live in your main home for 11 months, your home is a dwelling unit used as a personal residence. If you live in your vacation home for the other 30 days of the year, your vacation home is also a dwelling unit used as a personal residence unless you rent your vacation home to others at a fair rental value for 300 or more days during the year. |
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You are considered to use the property as a residence if your personal use is more than 14 days, or more than 10% of the total days it is rented to others if that figure is greater. For example, if you live in your vacation home for 17 days and rent it 160 days during the year, the property is considered used as a residence and your deductible rental expenses would be limited to the amount of rental income.
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| A day of personal use of a dwelling unit is any day that it is used by: |
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- You or any other person who has an interest in it, unless you rent your interest to another owner as his or her main home under a shared equity financing agreement;
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- A member of your family or of a family of any other person who has an interest in it, unless the family member uses it as his or her main home and pays a fair rental price;
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- Anyone under an agreement that lets you use some other dwelling unit;
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- Anyone at less than fair rental price.
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If you use the dwelling unit for both rental and personal purposes, you generally must divide your total expenses between the rental use and the personal use based on the number of days used for each purpose.
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When owned property is used for vacation purposes and is rented out part of the time, that property must be treated the same way as a business would. For example:
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- Receipts and invoices for repairs, improvements, and services should be kept.
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- You should have a separate checking account for the receipt of rent payments and for payment of rental expenses such as cleaning after a renter vacates. Not only will this separation make accounting easier, but it will also keep the IRS happy.
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- The days that the vacation home is used for personal use should be tracked. It's not enough to know off the top of your head what days were spent at the vacation property. Instead, a designated calendar should be employed that clearly shows both personal and rental use to be absolutely sure the use meets the IRS tests for vacation homes.
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However, you will not be able to deduct your rental expense in excess of the gross rental income limitation (your gross rental income less the rental portion of mortgage interest, real estate taxes, and casualty losses, and rental expenses like realtors' fees and advertising costs).
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| Even so, you may be able to carry forward some of these rental expenses to the next year, subject to the gross rental income limitation for that year. If you itemize your deductions on Form 1040, Schedule A, you may still be able to deduct your personal portion of mortgage interest, property taxes, and casualty losses on that schedule. |
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| Another special rule applies if you rent part of your home to your employer and provide services for your employer in that rented space. In this case, report the rental income. You can deduct mortgage interest, qualified mortgage insurance premiums, real estate taxes, and personal casualty losses for the rented part, subject to any limitations, but do not deduct any business expenses. |
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| You must also keep in mind that, generally, any short-term rentals, typically called transient rentals, even just for a weekend, have a state and local tax obligation. |
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| When it comes to selling your vacation home, generally, you can exclude up to $500,000 ($250,000 for individuals) in gains from the sale of a primary home that you lived in for at least two of the prior five years. The Housing Assistance Act of 2008 makes it impossible to convert a vacation home into a primary residence in order to reduce gains and subsequent taxes. However, upon sale, a vacation home may qualify for some gain exclusion if it has been used as a principal residence for any two of the five years before the sale. |
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Please consider this as just an introduction to all the information about rental property, including special rules about personal use and how to report rental income and expenses.
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| You can find out more details in IRS Publication 527, Residential Rental Property (Including Rental of Vacation Homes) available at IRS.gov. |
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| Of course, as we will always tell you, a good tax professional can help you organize the data for the business and personal use of your second home. They can also discuss with you the best ways to minimize taxes on both your rental income and ultimate sale. |
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