Are you considering the purchase of a vacation beach house, lakefront property, or Airbnb rental? Or maybe you already own one? Either way, you might be curious about the tax implications of renting it out part of the year.
Day Count
The tax treatment hinges on the number of days the property is rented out and your level of personal usage. Personal usage encompasses vacation time taken by your relatives (even if they pay market rate rent) and non-relative usage if market rate rent isn't charged.
If the property is rented for less than 15 days in the year, it's not classified as "rental property" for tax purposes. In certain scenarios, this can yield significant tax advantages. Any rental income received isn't taxable, regardless of the amount. However, you can only deduct property taxes and mortgage interest—no other operational expenses or depreciation. (Mortgage interest is deductible on your primary residence and one other home, subject to specific limits.)
If the property is rented for more than 14 days, you must report the rental income. Yet, you can deduct a portion of your operational expenses and depreciation, following certain guidelines. Initially, you must apportion your expenses between personal and rental usage days. For instance, if the house is rented for 90 days and used personally for 30 days, 75% of its usage is rental (90 days out of 120 total days).
Consequently, 75% of maintenance, utilities, insurance costs, etc., would be allocated to rental. Similarly, 75% of depreciation allowance, interest, and property taxes would be allocated to rental. Taxes on the personal use portion are separately deductible. Interest on a second home's personal use portion is also deductible if personal usage exceeds the greater of 14 days or 10% of rental days. However, depreciation on the personal use portion is not allowed.
Income and Expenses
If rental income surpasses these allocated deductions, you report the rent and deductions to determine the rental income to add to your overall income. If expenses exceed income, you might be eligible to claim a rental loss, depending on your personal usage of the property.
Here's the criteria: if personal usage exceeds the greater of 14 days or 10% of rental days, you're considered to be using it "too much," and you can't claim a loss. However, you can still utilize your deductions to offset rental income, but not to generate a loss beyond that. Unused deductions are carried forward for potential use in subsequent years.
If you're restricted to using deductions up to the amount of rental income, you must apply the deductions allocated to the rental portion in the following order:
Interest and taxes,
Operational costs, and
Depreciation.
If you meet the personal use test, you must still apportion expenses between personal and rental segments. In this scenario, if rental deductions exceed rental income, you can claim a loss. (However, this loss is considered passive and may be subject to limitations under passive loss rules.)
Strategize for Optimal Results
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As evident, the rules are intricate. Feel free to reach out if you have queries or would like to strategize to maximize deductions by scheduling a meeting with your VAAS Tax Consultant. We look forward to working with you.