Simone Lawson
The distinction between personal and business use of a vacation home is important for tax purposes. The IRS considers a vacation home a rental property when it is rented out for more than 14 days during the year, and personal use does not exceed 10% of the days rented or 14 days. If you rent your vacation home for fewer than 15 days in a year, you do not need to report the rental income, and it is considered a personal residence. However, you cannot deduct rental expenses. When rented for more than 14 days, the property is considered a residence, and rental income must be reported. The distinction between personal and business use impacts the allocation of expenses and deductions, with implications on capital gains and losses.
| Characteristics | Values |
|---|---|
| IRS classification as a residence | Used for personal purposes for more than 14 days and 10% of the total number of days the home is rented at a fair rental value |
| IRS classification as a rental property | Rented out for more than 14 days during the year and personal use does not exceed 14 days or 10% of days rented |
| Tax treatment when classified as a residence | Rental income is reported on Schedule E. Direct rental expenses, such as rental fees and advertising, are deductible against income. |
| Tax treatment when classified as a rental property | Rental income must be reported to the IRS using Schedule E. Owners can deduct expenses associated with the residence. |
| Tax treatment when rented for 14 days or fewer | Rental income does not need to be reported. Rental expenses cannot be deducted. |
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What You'll Learn
Personal use days vs rental days
The number of personal use days versus rental days of a vacation home determines whether it is considered a residence or a rental property by the IRS. This distinction is important as it affects the taxes that need to be paid on the property.
If a vacation home is rented out for 15 days or more per year, it is considered a rental property by the IRS and the rental income must be reported. In this case, owners can deduct any expenses associated with the residence, such as mortgage interest, property taxes, and casualty losses. However, if the home is considered a personal residence, these deducted expenses cannot exceed the rental income.
On the other hand, if a vacation home is rented out for fewer than 15 days per year, it is considered a residence. In this case, the rental income does not need to be reported, but neither can any rental expenses be deducted.
It is important to note that personal use days include not only days when the owner uses the property for themselves but also when it is used by family members, under a reciprocal sharing arrangement, or for repairs and maintenance.
Additionally, when a vacation home is sold, any capital gains must be reported to the IRS as they are treated as personal capital assets. Owners are taxed on the profits of the sale, which are reported separately from the owner's annual tax return.
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Tax implications of selling a vacation home
The tax implications of selling a vacation home can be complex and depend on various factors, including how the property was used and how long it was owned. Here are some key considerations:
Rental Income and Deductions
If you rent out your vacation home for 15 days or more per year, the IRS considers it a rental property, and you must report the rental income on your tax return. You can deduct certain expenses associated with the rental, such as mortgage interest, property taxes, casualty losses, advertising costs, and maintenance fees. However, if the vacation home is also used as a personal residence, there are limitations on the amount of rental expenses you can deduct.
Capital Gains Tax
When you sell a vacation home, you are typically taxed on the capital gains, which is the profit from the sale. This is reported on Schedule D of your tax return for the year of the sale. The tax rate on capital gains can vary depending on factors such as the amount of gain and how long you owned the property. It's important to note that there is no exemption on capital gains tax for vacation homes, unlike primary residences, which have a substantial tax benefit.
Principal Residence Exclusion
If you used the vacation home as your principal residence for at least two of the five years before the sale, you may qualify for the tax-saving principal residence gain exclusion. This exclusion allows single filers to exclude up to $250,000 in gains and up to $500,000 for couples filing jointly. However, there are conditions, such as not claiming an earlier gain within the two years before the later sale.
Net Investment Income Tax (NIIT)
If you owe the 3.8% NIIT, the effective federal rate on your net long-term capital gains can increase to 18.8% or 23.8%. Additionally, if you've deducted depreciation for rental periods, the federal rate on the gain attributable to depreciation can be up to 25%.
Personal vs. Business Use
The IRS considers a vacation home a rental property when it is rented for more than 14 days a year, and personal use does not exceed 14 days or 10% of the days rented. If you rent your vacation home for fewer than 15 days a year, you do not need to report the rental income, but you also cannot deduct any rental expenses. Understanding the distinction between personal and business use is crucial when determining the tax implications of selling your vacation home.
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How to deduct expenses
The IRS considers a vacation home to be a rental property when it is rented out for more than 14 days during the year and personal use does not exceed 14 days or 10% of the days rented. If you rent out your vacation home for 14 days or fewer, you do not have to report the rental income on your tax return and you cannot deduct any rental expenses.
If you use your vacation home for both rental and personal purposes, you must divide your total expenses between rental and personal use based on the number of days used for each purpose. You can deduct expenses such as repairs, maintenance, property taxes, mortgage interest, utilities, insurance, depreciation, and advertising costs from your rental income. If you rent out your vacation home for more than 14 days, you must report your rental income and expenses on Form 1040 or 1040-SR, Schedule E, Part I.
If your adjusted gross income is below $100,000, you can deduct up to $25,000 for rental losses, which is the excess of your rental expenses over your rental receipts. This deduction gradually phases out between an adjusted gross income of $100,000 and $150,000. You can carry forward excess losses to future years or offset losses to offset gains when you sell.
Additionally, if you travel to your vacation home to make repairs, you can deduct your transportation expenses as long as the trip is for necessary reasons and you have full documentation to prove it wasn't a leisure trip. You will need to provide the IRS with a thorough itinerary and a list of expenses, including timestamps.
It's important to keep detailed records of your expenses and maintain a separate checking account for your rental property to maximize your deductions.
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Rental income reporting requirements
The IRS considers a vacation home to be a rental property when it is rented out for more than 14 days during the year, and personal use does not exceed 10% of the total rental days or 14 days, whichever is greater. If you rent out your vacation home for fewer than 15 days during the year, you do not need to report any rental income or deduct any expenses.
If your vacation home qualifies as a rental property, you must report all rental income on your tax return. This includes advance rent, security deposits kept by the landlord (for example, to cover repairs), and any other payments made by the tenant, such as utility bills or repairs. Rental income is typically considered ordinary income and is taxed at your marginal tax bracket, which is between 10% and 37%. It is subject to federal and state income taxes and must be reported separately from ordinary W-2 income.
You can deduct expenses from your gross rental income. These include mortgage interest, property taxes, operating expenses, depreciation, repairs, advertising, payment of commissions, legal fees, and office supplies. You can also deduct expenses paid by the tenant if they are deductible rental expenses. However, you cannot deduct the cost of improvements to the property.
If you use your vacation home for both rental and personal purposes, you must divide your expenses between rental and personal use based on the number of days used for each purpose. If your rental expenses exceed your rental income, you may not be able to deduct all of your rental expenses.
If you are a cash-basis taxpayer, you report rental income on your return for the year you receive it, regardless of when it was earned. You deduct your rental expenses in the year you pay them. If you use an accrual method, you report income when you earn it and deduct expenses when you incur them. Most individuals use the cash method of accounting.
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Vacation home rules and exceptions
Vacation homes are a great way to escape for a break, but they also come with some financial considerations. The IRS considers a vacation home to be a rental property when it is rented out for more than 14 days during the year. If you rent it out for 15 days or more per year, the rental income must be reported to the IRS using Schedule E. If you rent it out for fewer than 15 days, you don't need to report the income, but you also can't deduct any rental expenses.
If you use the vacation home for personal, business, and rental purposes, you may trigger certain vacation-home rules. These include rules that require a split between rental and personal-use deductions, and rules that classify the rental part as either a personal residence or a rental property. It's important to note that if you rent out your vacation home, you may be subject to the net investment income tax (NIIT).
To be considered a residence by the IRS, a vacation home must offer basic living accommodations, including sleeping space, bathroom facilities, and cooking facilities. Additionally, it must be used for personal purposes for more than 14 days and 10% of the total number of days the home is rented at a fair rental value. If you use the dwelling unit for both rental and personal purposes, you must divide your total expenses between rental and personal use based on the number of days used for each purpose.
There are ways to bypass the vacation-home rules. For example, if you use your vacation home for overnight business lodging with no personal or rental use, it is considered a business asset and is deductible as such. However, if you have other residential rentals, staying at your vacation home to look after those rentals does not exempt you from the vacation-home rules.
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Frequently asked questions
The IRS considers a vacation home a rental property if it is rented out for more than 14 days during the year and personal use does not exceed 10% of the total number of days the home is rented. If you rent out your vacation home for 14 days or fewer, you do not need to report the rental income on your tax return and the house is considered a personal residence.
If you use your vacation home for both rental and personal purposes, you must divide your total expenses between rental use and personal use based on the number of days used for each purpose. You can deduct expenses such as repairs, maintenance, property taxes, and mortgage interest from the rental income, which can lower your tax liability.
Vacation homes are treated as personal capital assets, so owners are taxed on the profits of the sale, which are reported on Schedule D for the year the property was sold. This form accompanies the owner's annual tax return.
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