Vacation rentals have become a profit center for a lot of Americans. Some people have had success with renting out rooms in their house or their whole house through AirBnB or other online rental sites.
In this blog, we’re going to look at the tax breaks available NOW when you rent out part or all of your personal residence.
In general, you probably don’t want to turn your home into a rental property exclusively. That’s because you will lose all or part of the possible capital gains exclusion when you sell. That’s $250,000 of capital gains exclusion if you are single or $500,000 of married, filing jointly. If you live in your home as your primary residence for 2 of the previous 5 years, you will likely get some of that exclusion. But if you think it’s a slam dunk that you’ll get all of it, please read this.
The 2008 Housing Assistance Tax changed this exclusion if you move into a home that had previously been rented. You must pro-rate the capital gains amount to show what part was applicable to the rental time. Just be aware of this. There is a lot of bad information still floating around the Internet about the 2 out of 5 year rule. It changed over 10 years ago. Got a question about that? Join me at the Facebook group “Diane Kennedy’s USTax Group”, send in a question and I’ll write a blog answer sometime in the next two months or join me on the next coaching session through https://ustaxaid.com/coaching-program/.
That all said, what happens when you AirBnB your primary residence? Did you just mess up the possible capital gains exclusion?
First, you need to determine what is personal use and what is rental use. In general, a home is considered to have rental use when it is rented for fair market value.
Your house is considered to have a personal use day if, for any part of a day, the home is used by the owner, family members, use where you trade for use of another home or it is used by any other person or company if the fair market value is not paid.
You will need to have a count of your personal use days and of your rental days. They do not need to total 365 (or 366 in a leap year). For example, let’s say you spend a year outside the country and have your house available on AirBnB. It’s rented for 30 days and neither you nor a family member come back to the house during that year. You would have 30 rental days and no personal use days.
There are three possibilities with this example:
#1: You have less than 15 rental days in a year.
If you rent your home for less than 15 days, you don’t need to report the income. You don’t have to allocate your expenses to the rental. You don’t have to do any calculations to limit the possible capital gains exclusion.
It’s just tax-free money. Hooray!
#2: You rented it for 15 or more days and your personal use days do not exceed the greater of (1) 14 days or (2) 10% of total rental days.
Your home is now officially a rental property. It is not a primary residence, at least for that year.
So, let’s say you rented out your house for 200 days in the year. Your personal use days are 25 days. Your personal use days exceed the greater of 14 days or 10% of total rental days. So, this does apply to you.
If you have no personal use at all then all expenses associated with the house are rental expenses. You report the rental income less the deductions on your tax return, just like you would any other rental property. (Note: That a vacation rental is generally taxed like a business, not a passive investment property. That means a Schedule C business instead of a Schedule E, if you don’t otherwise have an entity set up that means you file another type of tax return.)
If you do have even 1 day of personal use, then you have to allocate a portion of the expenses to personal use. Because you don’t have a primary residence under the language of the code, you can’t take a mortgage interest deduction for the non-business use days.
#3: You rented it for 15 or more days and your personal days DO exceed the greater of (1) 14 days or (2) 10% of total rental days.
In this case, you DO still have a primary residence. The expenses are allocated based on use to the rental income. No rental loss is allowed because it is still your primary residence. The expenses just go to offset the income.
#4: You rent out a room for more than 14 days while you still live in your home.
Your personal use is greater than 14 days or 10% of rental days and so you can’t take a rental loss.
You can, however, allocate the expenses.
As an example, let’s say you have a house you live in and rent out through AirBnB for 20 days. That means you’ll have 365 days of personal use but 20 days of rental use. Rental use is subtracted so for purposes of the calculation, it is 345 days of personal use and 20 days of rental use.
You have to allocate in two different ways. First, allocate the indirect expenses based on square footage. If the room size is 10% of the total home, for example, then 10% of the mortgage interest, insurance, utilities, etc. are allocated to the rental income,
Some of the things we didn’t discuss here, that need additional conversation include when the rental is a business and when it’s a passive real estate investment and how to properly allocate capital gains.
You may have already realized there are a lot of possible strategies here. For example, let’s say you have a huge gain on your property. Can you turn it into a legitimate rental and do a like-kind exchange? Maybe. What if the property has really gone down in value? Can you turn it into a legitimate rental and then take a loss on sale? Perhaps.
Renting out your property as a part-time money-making venture can have some complicated consequences and strategies, once you exceed the magic 14 days of rental.
Want to know more about using AirBnB to create a cash flow AND pick up a tax break? Join us at https://www.ustaxaid.com/coaching-program/ for more conversation.