The tax treatment of vacation rental property depends on how many days you rent it out and how much you use it yourself. If you rent your vacation property for less than 14 days a year, then you don’t have to report the rental income—plus you don’t deduct the expense of renting. However, if you rent it for more than 14 days, then you’ll need to report the rental income. If, in addition to renting, you stay there personally for more than 10% of the rental days or more than 14 days, then you will be unable to deduct any losses from the rental.
- The vacation home rules don’t allow a deduction for any loss from mixed-use homes, which are rental properties with both personal and rental usage.
- Mixed-use homes exclude personal-use homes that were rented for less than 15 days during the year.
- Mixed-use homes exclude rental homes that were used personally during the year for less than the greater of 15 days or 10% of the number of rental days.
1. Tax Rules for Homes With Minimal Rental Activity
If you rent out your personal dwelling for less than 15 days during the tax year, the rental use will be ignored. Under this rule, your property will be considered a personal residence and not mixed-use property.
For the purpose of this rule, a dwelling is a house, apartment, condominium, mobile home, boat, vacation home, or similar property. A dwelling unit excludes property used solely as a hotel, motel, inn, or similar establishment where the owner does not use it as a home during the year.
Treatment of Income & Expenses
If you engage in minimal rental activity during the tax year, you don’t need to claim any income or expenses on Schedule E. Furthermore, 100% of property taxes and mortgage interest can be deducted on Schedule A without any allocation of the expenses to the rental use.
Naomi owns a rental property. During the year, she rented out the home for 12 days but made it available for rent for 30 days. For those 12 days, Naomi earned $1,200 and also incurred $300 in rental-related expenses.
Although the property generated revenue and she incurred expenses, since she rented out the property for less than 15 days during the tax year, she will not report any of the income or expenses on her tax return. However, Naomi had the following expenses during the tax year.
- Property taxes: $5,000
- Mortgage interest: $12,000
- Advertising fee: $500
- Cleaning service fee: $1,000
Since Naomi’s activity falls under the minimal use rule, she can deduct all her property taxes and mortgage interest on Schedule A just like any other homeowner. The advertising and cleaning service fees are non-deductible.
2. Tax Rules for Homes With Minimal Personal Use
If you personally used the property for less than 14 days, or 10% of the total days it was rented to others at a fair rental price, then your property will be considered a rental property, not mixed-use property, by the IRS. Since it’s not mixed-use property, losses are not disallowed under the vacation home rules.
Most of the time, all deductible expenses linked to a property are split between fair rental days and personal use days based on the ratio of fair rental days to the total number of days used. Even though this is true, direct rental expenses—such as rental agency fees, advertising, office supplies, and other expenses—cannot be allocated to personal use days.
Treatment of Income & Expenses
If, by this definition, your property is a rental property, you must include your rental income and expenses on Schedule E. Property taxes, mortgage interest, operating expenses, and depreciation are all deductible on Schedule E, but only after reducing them for the personal-use portion of the property. Since it is not a mixed-use property, the vacation home rules do not limit your ability to deduct a loss if your rental expenses exceed your rental income.
Even if your deductible loss is not limited by vacation home rules, your loss could still be limited by the passive loss and at-risk loss rules.
Passive loss rules prohibit deducting passive losses, like rental income, against non-passive income. Thus, without passive income, passive losses will be suspended and carried forward unless you have active participation in your rental property. The at-risk rules for rental properties limit the amount of allowable losses, so you cannot deduct more than you are at risk of losing in rental activities.
Diego owns a residential rental property. During the year, the property was used in the following ways:
- Diego rented out the property for 350 days and earned $10,000 and $15,000 in expenses
- His brother stayed in the property for 10 days and was not charged rent
- The property was unoccupied for 5 days
Although Diego’s brother’s occupancy counts towards Diego’s personal use days, he used the property for less than 14 days during the tax year. As such, the IRS will treat it as a rental property and not a mixed-use property.
Diego’s income and expenses are as follows:
- Rental percentage: 350 days/360 days = 97.2 %
- Rental expenses: $15,000 x 97.2 % = $14,580
- Rental loss/gain: $10,000 – $14,580 = $4,580
Given, Diego will include the $4,580 loss on Schedule E if allowed under the passive loss rules.
3. Tax Rules for Mixed-use Vacation Homes
You may use your property for both business and personal purposes—this is called a mixed-use property. Your property is mixed-use if your
- Personal days are more than the greater of 14 days or 10% of rental days, and
- Rental days are more than 14 days
If your property falls into this category, you will not be allowed to deduct any loss if your rental expenses exceed your rental income.
Treatment of Income & Expenses
Step 1: Determine Your Rental Percentage
When you have a mixed-use property, you must divide your expenses between rental and personal use based on the number of days that apply to each.
When dividing your expenses, be sure to follow these rules:
Personal Use Day
You occupy the property for any part of the day.
Any day that the home is rented out at the fair rental price—even if it is also used for personal reasons on that day.
The property is used by a member of your family—unless they use it as their main home, and they pay the fair rental price.
Any day that a property is held out for rent, but not actually rented.
The property is occupied by someone who is renting it for less than a fair rental price.
Step 2: Group Expenses I Into Four Tiers
- Tier 1: Direct rental expenses, such as advertising and leasing agent fees
- Tier 2: Mortgage interest and property taxes
- Tier 3: All other rental expenses except depreciation
- Tier 4: Depreciation
Step 3: Reduce Rental Income by Tier 1 Expenses
Tier 1 expenses are directly related to the rental and would not have been incurred if the house had not been available for rent. Therefore, tier 1 expenses are 100% deductible against rental income on Schedule E.
Step 4: Reduce Rental Income by Tier 2 Expenses
Tier 2 expenses are mortgage interest and real estate taxes that would be deducted on Schedule A as itemized deductions if the house had not been rented out. These expenses must be allocated between rental and personal use based on the rental percentage. The personal-use portion of tier 2 expenses can be deducted on Schedule A.
The rental-use portion of tier 2 expenses can reduce the rental income after tier 1 expenses down to zero, but tier 2 expenses cannot create a loss. Any excess tier 2 expenses are deducted on Schedule A and cannot be carried forward to future years.
Step 5: Reduce Rental Income by Tier 3 Expenses
Tier 3 expenses are most of your expenses for maintaining the house, such as utilities and maintenance. These expenses must be allocated between rental and personal- use based on the rental percentage. The personal-use portions are not deductible.
The rental portion of tier 3 expenses can reduce income after tier 2 expenses but cannot create a loss. If all of the rental income is offset by tier 1 and tier 2 expenses, then all the tier 3 expenses will be disallowed. Any unused tier 3 expenses carry over and can offset rental income from this property in future years.
Step 6: Reduce Rental Income by Tier 4 Expenses
Depreciation is usually the only tier 4 expense. Allocate depreciation to the rental property by using the rental percentage. Depreciation allocated to personal use is not allowable and does not reduce your basis in the property.
Rental depreciation can offset rental income after tier 3 expenses but cannot create a loss. Any disallowed depreciation does not carry over, but it also does not reduce the basis in the house.
The reason it’s important to deduct mixed-use vacation home expenses in a particular order is to determine the type of expense that is disallowed in the event expenses exceed income. We must know the tier of the disallowed expense to know how to treat the disallowed expense.
In 2022, Amara rented out a rental property that she also used for personal use.
She rented out the home for 250 days and received $8,000 in rental income. She used the home for 50 days during the year, and her brother Arinze used the home for 65 days during the year. Amara incurred a total of $9,000 in costs associated with operating the home. These rental expenses consisted of $500 in advertising expenses, $2,500 in mortgage interest and property taxes, $5,000 for miscellaneous expenses, and 5,000 in depreciation.
Let’s figure out her rental percentage and rental expense:
- Step 1: 250 / (250 + 115) = 68.49% rental percentage
- Step 2: Group Expenses into four tiers:
- Tier 1: $500 in advertising expenses
- Tier 2: $2,500 in mortgage interest and taxes
- Tier 3: $5,000 in miscellaneous expenses
- Tier 4: $5,000 in depreciation.
- Step 3: Offset rental income with 100% of the tier 1 expenses:
$8,000 – $500 = $7,500
- Step 4: Offset the remaining rental income with the rental portion of tier 2 expenses:
$7,500 – ($2,500 x 68.49%) = $5,788
The personal portion of tier 2 expenses can be deducted on Schedule A.
- Step 5: Offset the remaining rental income with the rental portion of tier 3 expenses:
$5,788 – ($5,000 x 68.49%) = $2,364
The personal portion of tier 3 expenses is not deductible.
- Step 6: Offset the remaining rental income by the rental portion of tier 4 depreciation expense:
$2,364 – ($5,000 x 68.49%) = $1,061 Loss
Since Amara’s property is a mixed-use vacation home, the $1,061 loss is disallowed. It’s disallowed by reducing the tier 4 depreciation expense to $2,364, which is the rental income remaining after tier 3 expenses. The home’s basis is only reduced for the $2,364 of actual depreciation claimed rather than the full amount and there are no disallowed deductions carried forward to next year.
Frequently Asked Questions (FAQs)
No, you do not have to keep records of the rental income and expenses because you are not reporting any rental income or deducting any rental expenses.
No, any day that you spend repairing and maintaining your property is not counted as a day of personal use.
If you rent out your vacation home for more than 14 days during the year, you need to allocate property tax expenses between the rental and personal use. The personal portion can be deducted on Schedule A but counts toward the $10,000 state and local tax (SALT) limitation. The rental portion of property tax is reported on Schedule E and does not count toward the SALT limitation.
To claim deductions for a vacation rental property, you must follow certain rules depending on the categorization of the property. Keeping track of the number of days the property is used for personal purposes vs rental purposes is essential to claiming deductions properly.