Vacation Home or Rental House? The Difference Can Mean Big Money | USTaxAid

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Vacation Home or Rental House? The Difference Can Mean Big Money

Written by Diane Kennedy, CPA on July 23, 2021

In this world of AirBnB and vacation rentals, there are a lot of options for vacation homes. It could be a second home, that is enjoyed just by your family and friends. It could be a regular rental property. It could be an AirBnB type rental.

Which is right for your property? And even more importantly, which will give you the best tax breaks now?

The answer becomes even more difficult when there is mixed use. 

Is your vacation home classified as a personal residence or a rental property?

Good question. Here’s what the Internal Revenue Code and IRS regulations say about how to classify “mixed-use” vacation properties that have both rental and personal use during the year.

Your vacation home is considered a rental property if:

You rent it out for more than 14 days during the year and

Personal use during the year does not exceed the greater of: (1) 14 days or (2) 10% of the days you rent the home out at fair market rates. 

Personal use includes use by the owner, family member or anyone who pays less than fair market rental rates.

Your vacation home is considered a personal residence (second residence) if: 

You rent it out for more than 14 days during the year and

Personal use during the year exceeds the greater of: (1) 14 days or (2) 10% of the days you rent the home out at fair market rates. 

If the property is a rental property, there is still a question on tax treatment. Is it a vacation rental like an AirBnB or is it a long-term rental?

If the property rents for an average of 7 days per stay or less and the owner provides “substantial services” (usually defined as maid service, it is a business. Otherwise, long term rental are considered passive real estate investments. 

Tax Treatment of Second Homes, Real Estate Business and Passive Real Estate Investments

If a property is considered a second home or personal vacation home, mortgage interest and property tax may be allowed as deductions. The mortgage interest is only allowed if your primary and secondary home total acquisition indebtedness is $750,000 or less (if purchased in 2018, otherwise the amount is $1 million). If your indebtedness is more, than a portion of the mortgage interest is not deductible. 

Property tax is only deductible to the total amount of $10,000 when added to state income taxes paid. For most people, property tax and/or income tax deductions are limited due to the $10,000 threshold. 

Part Rental/Part Vacation Tax

Mortgage interest, property tax and other expenses must be allocated between rental and personal use based on actual days of rental and personal use occupancy. 

Mortgage interest that is allocated for personal use using this formula is not deductible as an itemized deduction. The rental use would be considered a deduction for rental income. The same is true for utilities, insurance, repairs and depreciation attributed to the personal use. There is no deduction for those expenses. 

There is, however, a deduction allowed for the personal portion of property taxes, provided you’re under that $10,000 limit for state and local taxes. 

Otherwise, the passive real estate income less apportioned expenses is your net income or loss. 

Part Business/Part Vacation Tax

The expense allocations work the same if you’re renting out your property for short term stays (business) as when you’re renting your property for long term stays (passive real estate).  The difference is that the non-personal income and expenses are treated differently. 

If you have short term stays, you have a business. That means it’s reported on a Schedule C, Sole Proprietorship. If you have net income, it’s subject to self-employment tax. If you have a loss, it’s much easier to deduct against other income. 

When It’s Time To Sell

If you sell at a gain: 

A vacation home gain will be taxed at the capital gains rate. 

The same is true for the short-term stay/business property and the long term/passive real estate property. The gain will be taxed at the capital gains rate and you will need to recapture depreciation at the recapture tax rate.

If you sell at a loss: 

A vacation home loss is not deductible. 

The loss will be deductible against other income for both the short-term stay/business and long term/passive real estate property.

The best tax strategy is to turn your vacation home into a rental or business property that you use part time. Just make sure you’re following the rules and don’t overstay your welcome!

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