Vacation Home Rental Tax Rules

You might own a home that you live in part of the year and rent out part of the year. If so, prorate the expenses you incur between personal and rental use. Since vacation homes usually get this kind of treatment, the rules you must follow are known as vacation-home rules.

Home used mostly by the owner

If the home is your main home and you rent it out for fewer than 15 days during the year, you don’t need to report income. However, you can’t deduct expenses associated with the rental. You can, however, claim the usual homeowner deductions for:

• Mortgage interest
• Real-estate taxes
• Casualty losses

Mixed use by owner and tenant

If you rent the home for 15 days or more, report the rental income on Schedule E. You can deduct expenses, but you must prorate them, and they might be limited.

If the home is considered a residence, the expenses you deduct can’t be more than the rental income. If the home isn’t a residence, the expenses you deduct can be more than rental income. However, your loss would be limited by the passive-activity rules.

To be considered a residence, a home must pass both of these tests:

• It must provide basic living accommodations. So, it must have a sleeping space, bathroom facilities, and cooking facilities. A residence might be one of these:
  • House
  • Apartment
  • Condominium
  • Mobile home
  • Motor home
  • Houseboat
• It must pass the personal-use time test. A home is considered a residence if you use it for personal purposes for more than the greater of these:
  • 14 days
  • 10% of the total number of days you rent the home at fair rental value

Personal-use time

The amount of time you personally use a home includes use by:

• Any person who has an ownership interest in the home. This is not true if the home is rented to another owner as his or her main home under a shared equity financing agreement.
• A family member of any person who has an ownership interest in the home. This is true unless the family member uses the home as his or her main home and pays fair rental value. Family members include:
  • Brothers and sisters
  • Half brothers and half sisters
  • Spouses
  • Lineal ancestors like parents or grandparents
  • Lineal descendants like children or grandchildren
• Any person who pays less than fair rental value to use the home. This doesn’t apply to an employee who uses the home as lodging at the owner / employer’s convenience.
• Any person who uses the home under a home-exchange arrangement with the owner. It doesn’t matter if the use is rent-free or paid.A tenant paying fair rental value might allow the owner to stay in the home. If so, the time is considered personal use when deciding if the dwelling is a residence. When figuring the ratio for prorating expenses, the time is counted as rental use. (See Rental-use time below.)
• Any time you spend at the home repairing and maintaining it doesn’t count as personal-use time.

Rental-use time

You must count the number of days of rental use to figure the ratio to prorate expenses. Rental use is any day you rent the dwelling at a fair rental value. So, you can only count the days when you actually receive rent payment to figure the ratio.

How to prorate

To figure the proration rate, divide the number of days you rented the home at fair rental value by the total days used for both personal and business purposes. This method applies to all rental expenses.

What if my home qualifies as a residence?

If you rent out your home for at least 15 days and the days of personal-use qualify your home as a residence, vacation-home rules apply. These rules limit deductible expenses to rental income. You need to deduct expenses in this specific order:

1. The rental portion of:

• Qualified home mortgage interest
• Real-estate taxes
• Casualty losses

These expenses are deductible under the usual rules. You can only subtract the rental portion from rental income. The personal portion is deductible on Schedule A and subject to the usual rules.

2. Rental expenses directly related to the rental property itself, including:

• Advertising
• Commissions
• Legal fees
• Office supplies

3. Expenses related to operating and maintaining the rental property. You’ll deduct these up to the amount of rental income minus the deductions for items in 1 and 2. This includes interest that doesn’t qualify as home mortgage interest.
4. Depreciation and other basis adjustments to the home . You’ll deduct these up to the amount of rental income minus the deductions for items in 1, 2, and 3 above. This includes things like improvements and furniture.

To learn how to figure your deductions, see Worksheet 5-1 and its instructions in Publication 527: Residential Rental Property at www.irs.gov.

You can carry over expenses you can’t deduct due to the rental income limit. You can use the carryover in one of these time periods:

• First year you have sufficient income from the property
• When you sell the property

What if my home doesn’t qualify as a residence?

You might not have personally used the home long enough for it to be classified as a residence. If this is true, you must prorate the expenses of owning and maintaining the home. You should use this ratio to prorate your expenses:

Number of days of rental use / Total number of days used for business and personal purposes

However, deductions for expenses aren’t limited by rental income. You can use a rental loss to offset other income. This is subject to the usual passive-activity loss limitations.