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How Does the New Tax Law Treat Rental Vacation Property? by Angie Adames, CPA

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Posted on January 21, 2019 by Angie Adames

The prospect of having a vacation property that you can use as your own personal retreat for part of the year and lease to others in return for rental income during other times is appealing to many individuals. However, it is important to understand the tax implications of renting your residential property, whether it be a house, an apartment, a room or a boat, to ensure that you maximize the potential benefits without incurring unexpected tax liabilities.

In general, rental income is taxable unless you rent out a residential property 14 days or less during a calendar year. Once you hit the 15-day mark, you must report and pay taxes on any and all payments you receive for renting out the property during the year. However, under U.S. tax laws, you may be able to offset the rental income and reduce your tax liabilities if you qualify to deduct the expenses incurred for renting the property, including advertising, cleaning and maintenance, mortgage interest, property insurance and taxes. Your eligibility to take those deductions depends on the amount of time you spend renting the property as a business as compared to the amount of time you spend enjoying the property for personal use.

Personal-Use Residence vs. Rental-Use Business Property

The IRS classifies vacation homes as either personal residences used by you or your family members or rental business property.

A property is considered a personal residence when:

Conversely, the IRS will consider a vacation home to be rental income property for which you may be able to claim tax deductions for eligible business expenses when:

When calculating the number of days your home is used for personal vs. rental use, you must disregard any days in which the property was vacant or was undergoing maintenance and repairs. In addition, careful attention should be paid to the days in which you rent the property for less than the fair market rate, perhaps to a family owner or friend, which the IRS considers to be personal use.

Tax Treatment of Multi-Use Vacation Property

When a vacation home qualifies as rental property, you must allocate property taxes, costs for repairs and improvements and other potentially deductible business expenses between the actual days you rent out the property and the days you use it for personal enjoyment. As a rule, you may only deduct amounts that are proportional to the actual number of days you rent the property to non-family members. In addition, when you operate a property as a rental business, you may qualify to deduct up to $25,000 in losses per year from the rental income you earn. While you may not deduct rental expense in excess of the gross rental income limitation ( less the rental portion of mortgage interest, real estate taxes, and casualty losses, and rental expenses like realtors’ fees and advertising costs), you may be able to carry forward some of these rental expenses to the next year.

Due to the new tax law’s significant increase in the standard deduction, fewer taxpayers will take the time and effort to itemize many of the deductions they previously relied on to reduce their taxable income in prior years. Moreover, the tax law places significant restrictions on deductions for mortgage interest and property taxes, thereby limiting the potential tax savings that rental property owners can yield. For example, the mortgage interest apportioned to the personal use of a rental property may not be considered as an itemized deduction if the taxpayers did not use the property for more than 14 days.

Other Rules, Limitations and Exceptions to the Rules

Vacation homes classified as rental property may generate deductible losses for taxpayers whose rental expenses exceed their rental income. However, under the passive activity loss (PAL) rules, taxpayers may deduct losses from passive activities, including renting real estate, only from income that they generate from similarly passive activities. You may not, for example, deduct the losses from passive rental activities from the income you earn as wages from your full-time job. Any losses that do not qualify for a deduction under the PAL rules in the current year may be carried over into future years to be deducted when you have additional passive income or when you sell the rental property that created the passive losses.

There is an exception to the PAL rules that allows “certain” taxpayers who actively participate in rental activities and have adjusted gross income (AGI) of less than $100,000 to potentially deduct up to $25,000 of annual passive rental real estate losses from current year income. In addition, depending on the number of hours you spend materially participating in the delivery of real estate services, you may qualify as a real estate professional which means, the rule treating rental activities as automatically passive would no longer apply.

On a final note, if your property is located near the site of a major, multi-day event that attracts out-of-state visitors, such as the Miami International Boat Show, Art Basel or the South Beach Food and Wine Festival, you may be able to generate tax-free rental income as long as you do not rent out your property for 15 days or more during the year. This is especially beneficial in today’s economy, for which homeowners can quickly and easily market their properties, often, at unusually high short-term rates via services such as Airbnb and VRBO. In these circumstances, however, the property owner will not qualify as a business operator and will not be able to deduct any portion of expenses for repairs, maintenance, cleaning or rental agency fees.

Before handing over the keys to your vacation home, seek the guidance of professional accountants and advisors to help you navigate the complexity of the tax laws and maximize your earnings without increasing your tax liabilities.

About the Author: Angie Adames, CPA, is an associate director of Tax Services with Berkowitz Pollack Brant, where she provides tax and consulting services to real estate companies, manufacturers and closely held business. She can be reached at the firm’s Miami office at (305) 379-7000 or via email at info@bpbcpa.com.

Information contained in this article is subject to change based on further interpretation of tax laws and subsequent guidance issued by the Internal Revenue Service.