When you own a vacation home, it pays to plan ahead to avoid tax-time surprises that can cost you hundreds or even thousands of dollars.
“The main thing I see when I get new clients is that they’re not deducting all they could or should,” says Andrew Poulos, an accountant, national speaker and financial talk show host who works with vacation rental owners.
In addition to overlooking lucrative deductions, it’s easy to make small missteps that disqualify you from certain tax breaks. Here are five actions that can cause tax issues for owners of second homes:
- Taking extended vacations. If you love to kick back and relax at your vacation rental, that’s fine. But if you want your second home to be considered strictly an investment property for tax purposes, you’ll have to keep your personal use to two weeks or less — or no more than 10 percent of the time you rent it out at a fair market rate. Overstay and you won’t be able to deduct all of your expenses. If your rental property is “used as a home,” your deductions can’t exceed the amount of rent you receive, according to Internal Revenue Service vacation home tax rules. A Chicago attorney who owns a vacation rental near Lake Michigan, John O’Brien says he makes sure to limit his personal use of the house in order to maximize his deductions. “Anything I buy for the home — towels, dishes, forks, spoons —that’s all part of the cost of doing business,” he says.
- Counting business visits as personal use. On the other hand, don’t shortchange yourself by misclassifying business visits to your vacation rental as personal use. If you’re staying at your vacation rental so you can put a fresh coat of paint on the walls, repair a rotting deck or meet with a contractor, you don’t have to count that stay toward your 14 days of personal use, Poulos says. However, document your reason for visiting the property so you can prove it if you get audited by the IRS, he says. “If you go down to Home Depot to buy some paint or get some new patio chairs for the deck, keep your receipts,” he says.
- Renting on the cheap. If your Mom, best friend or Aunt Sally wants to stay at your vacation rental, don’t rent your place out at a cut rate just to be nice, says Deltrease Hart-Anderson, an enrolled agent who provides tax services for real estate professionals and other business owners. “You might think you’re doing your family member a favor, but you won’t be doing yourself any favors,” she says. In fact, any time you rent your vacation home for less than fair market value, it counts toward your personal use time. If that puts your total personal use time above 14 days, you may lose out on some tax deductions. “Rent to friends and family for the going rate,” she says.
- Leaving money on the table. One of the most common mistakes vacation rental owners make is failing to take the depreciation deduction, Poulos says. When you buy an income producing property, you can get that money back by deducting a portion of the purchase cost each year on your taxes, according to the IRS. But many vacation rental owners who don’t get advice from a qualified tax pro lose out on that tax benefit, Poulos says. “Depreciation can be a huge deduction and it’s a very common item to miss,” he says.
- Offering hospitality services. If you rent your property for 14 or fewer days each year, you don’t have to pay taxes on that rental income. The IRS exemption applies even if you rent out your home out during a big event and rake in tens of thousands of dollars, Hart-Anderson says. “You don’t even have to tell the IRS about it,” she says. But in order to keep that tax benefit, you’re not allowed to provide “substantial services” for your guests — that is, any services that would put you in direct competition with local B&Bs, hotels or motels, Hart-Anderson says. “If you make breakfast, change the sheets or offer a swim in the pool, you’re offering services that would make your rental income taxable,” she says. She adds: “If you offer the amenities of a hotel or motel, it looks like you’re in competition with the hospitality industry, and you’ll have to play by the same rules they do.”
Tax rules around vacation rentals are very complex, so it pays to get expert help. Here are three tips to avoid tax troubles with your property:
- Get a qualified tax pro. Some vacation homeowners get their taxes done by a less-than-qualified tax preparer who doesn’t understand the ins and outs of vacation home rentals. Not all CPAs are well-versed in taxes, so Hart-Anderson recommends finding an enrolled agent, a tax expert licensed by the federal government to represent taxpayers in front of the IRS. The National Association of Enrolled Agents offers a search tool to help you find an enrolled agent.
- Brush up on the rules. Learn the basics of tax rules around renting your vacation home. Then strategize with your tax professional to maximize the tax benefits of your vacation rental, Hart-Anderson says.
- Keep good records. “Record keeping is key,” Poulos says. Keep detailed records showing when you used the home for personal use, when you stayed there for business purposes, and the rental details. Record the name of the renters, the dates the property was rented, the rate, and the total amount collected. “That should match the amount of money going into your bank account,” he says.