Vacation Home Rentals

A second home in the country, a condo in the city, or a houseboat on the lake can all be pleasant places to spend your vacation. They can also be made to partially pay for themselves, if you can rent them out to others for a portion of the year.

Rented for less than 15 days. The IRS uses a two-week de minimus rule before applying vacation home rental rules. If you rent out a vacation home for two weeks or less during the year, you don't have to report any rental income you receive, but you can't deduct any rental expenses you have (except for the normal home mortgage interest and real estate tax deductions you'd have anyway). Essentially the IRS will ignore this small amount of rental activity.

Rented for more than 14 days. If you have property that is rented out for more than 14 days during the year, and you or your family, or any co-owner or his or her family, use it for personal purposes for even one day of the year, you have to divide all the expenses of the property into two buckets: "personal" and "rental."

The rental expenses will generally be deductible on Schedule E, Supplemental Income and Loss, and the personal expenses will not be deductible except for mortgage interest, real estate taxes, and casualty losses that you could ordinarily claim on Schedule A.

On Schedule E, you can deduct the entire amount of expenses that apply only to renting, such as advertising, commissions, credit checks, etc. For all expenses that apply to the entire home, such as mortgage interest, real estate taxes, insurance, utilities, and repairs and maintenance on the furnace, roof, electric system, etc., you must generally divide the expenses on the basis of days spent for personal use, compared to days that the property was rented at a fair market rate; the total need not add up to 365 days.

When counting days of "personal use," you must include any days that you donated the use of your property to a charitable organization (for example, if you allowed a charity to auction off a week in your lakefront house). Also count as "personal" any days that you traded with someone else for the use of a different property, or any days for which you charged less than fair market rent. However, don't count as "personal" the days you stayed in the home because you were having repairs or maintenance done, even if your family stayed with you.

Example You have a cabin in the mountains that you generally rent out during a three-month ski season; this year, the rental agent was only able to rent the property for 60 days out of the 90 days it was available. You donated a week of this unrented period to a local charity. Also, you spent a week at the cabin cleaning and making repairs before the rental period began. You would count as "personal use" the 7 days you donated to charity, and you would count as "rental use" the 60 days you actually rented the property. Therefore, 7/67 of your expenses would be treated as "personal" and deductible, if at all, on Schedule A. 60/67 of your expenses would be treated as "rental" and deductible on Schedule E, subject to the limits discussed below. The 7 days spent cleaning and making repairs do not count as either personal or rental use.

Dwelling unit used as a home. An even more severe restriction applies if you (or your family, or any co-owners or their families) use the property for personal purposes for more than the greater of 14 days, or 10 percent of the days it is rented out to others.

In that case, not only do you have to apportion your expenses between the "rental" and the "personal" portion, but also if your rental expenses exceed your rental income for this mixed-use property, you can only deduct your expenses up to the amount of your income. Any remaining expenses can be carried over and deducted in the next year, however.

You don't have to apply this additional limit if you converted rental property to a personal residence during the year.

Warning Beginning in 2013, a new 3.8 percent net investment income tax may be imposed on individuals whose modified adjusted gross income exceeds $250,000 for joint filers, $125,000 for married taxpayers filing separately, and $200,000 for others. Trusts and estates with income over a certain amount are also subject to the NII tax. Form 8960, Net Investment Income Tax— Individuals, Estates, and Trusts is attached to the tax return. For 2013, the IRS has provided taxpayers the ability to rely on more than one set of net investment income tax rules. The best choice varies by taxpayers and depends on the taxpayer's unique situation. Consult your advisor to determine which approach would be best for you. Also, consider that the IRS has issued new depreciation regulations that generally apply to tax years beginning on or after January 1, 2014. But, for 2012 and 2013, it also provided taxpayers with the ability to elect certain regulations. The best choice for each taxpayer depends on the taxpayer's unique situation. Consult your advisor to determine which approach would be best for you and your business.

You also don't have to apply it if you converted a personal residence to a rental during the year and you rented or tried to rent it out for at least 12 months, or if you would have rented it for at least 12 months except that you sold or exchanged the property before the 12 months were up.

Planning Tools You can use this worksheet to compute the additional limit on rental deductions for property that is used partly for a home, and partly for rentals.