Owning a vacation rental home can be richly rewarding. It also, however, can be taxing.
If you’re renting out a vacation home for profit, the tax circumstances surrounding ownership of the property are far different from the tax circumstances you face if you and your family are the only ones using it.
Therefore, it’s smart to keep on top of the tax implications of owning a vacation rental home, especially since a massive overhaul of the federal tax code recently was enacted.
“[Vacation rental homes] can be a great way to make some extra cash, but if you don’t handle the rental income properly on your tax return, you might end up getting stuck with high penalties and fees from the IRS,” says tax accountant Thomas Williams, owner of Your Small Biz Accountant LLC.
Here are 6 things to keep in mind while you prepare your 2018 taxes:
Pay Attention to Tax Law Changes
The federal tax overhaul, passed in December 2017, institutes significant revisions that affect owners of vacation rental homes, although the majority of revisions will affect returns filed for the 2018 tax year.
- Previously, state, city, and real estate taxes could be deducted in full, says Josh Zimmelman, owner of Westwood Tax & Consulting LLC in Rockville Centre, New York. Under the new tax plan, they’re limited to a total of $10,000 for married taxpayers and $5,000 for single taxpayers.
- In the past, mortgage interest was deductible up to $1 million. Under the new tax plan, only mortgage interest up to $750,000 is deductible for married taxpayers and $375,000 for single taxpayers. These new thresholds apply to new home purchases. Current homeowners will stick to the old thresholds for mortgage deductions.
- As a result of the new tax law, Bill Hughes, managing partner of Business Allies Group LLC in Stuart, Florida, recommends looking into establishing a partnership (known as a pass-through entity) for your rental property, a scenario that will allow income from the property to be taxed at 20% less than the regular rate.
Zimmelman says some vacation rental sites will withhold taxes from your rental income. The taxes are automatically added to the rent, and the taxes owed are sent to the IRS on your behalf.
However, other vacation rental sites may require you to report and pay taxes on your own, Zimmelman says.
“Check each individual program’s policies and procedures before making any assumptions and finding yourself stuck with a surprise tax bill,” he says.
Use the Correct Forms
Someone who rents out a room without any bells and whistles will probably use IRS Schedule E to report rental income and pay taxes on that income (after expenses are deducted), according to Zimmelman.
But if your vacation rental goes above and beyond – for instance, you offer housekeeping services – then you’ll want to file IRS Schedule C and pay self-employment taxes in addition to income taxes. Those who do file Schedule C should set up estimated quarterly tax payments to avoid being hit with an out-of-sight tax bill, Zimmelman advises.
Follow the 14-Day Rule
If you rent out your home for fewer than 14 days during the year and use the property yourself for more than 14 days during the year – or at least 10% of the total days you rent it out – that rental income is tax-exempt, according to Zimmelman. This rule applies to renting out an entire home or just one room.
“Of course, if the rental income can’t be taxed, you also can’t claim any business deductions for rental expenses,” he says.
The new tax law made no changes to the 14-day rule.
Track All Expenses
You can deduct typical expenses related to renting out your vacation home, such as listing fees, housekeeping services, or supplies like towels and bedding, Zimmelman says.
You also can deduct a portion of expenses incurred for both personal and rental purposes, such as utility bills. To do that, you’ll need to figure out which percentage of the year you rent out the home and then, deduct that percentage of joint expenses.
“Recordkeeping is essential. You need to keep all receipts, not just bank statements and credit card bills,” Hughes says.
Learn more about tax deductible home improvements here.
Look Into Cost Segregation
Hughes says cost segregation is a great tax strategy for vacation rental homes valued at more than $300,000, excluding the land. This method helps the owner depreciate some costs in less time than the customary 27.5-year period.
Through cost segregation, certain expenses – such as a new roof, new furnishings or new appliances – can be written off over 5-, 7- or 15-year periods rather than over the full 27.5-year period.
Jonathan Senigaglia, a tax and management consultant in Redwood City, California, says he recently helped the owner of $5 million worth of rental properties capture about $230,000 in cost segregation deductions for just one tax year.
“Many property owners have not heard of this type of tax savings, but the benefits are stark,” Senigaglia says. “Once the tax savings are secured, the owner can reinvest that money and grow it, not to mention the benefits of claiming a large sum today before inflation can slowly degrade the value of that sum.”
Some property managers, like TurnKey, will help homeowners during tax season to help decipher the process. Tax preparation can get pretty complicated if you own a vacation rental home, have a traditional residence, and receive income from various sources. If you feel like you’re in over your head when it’s time to do your taxes, consider hiring a tax professional to file your returns.
For more information about filing taxes as a vacation rental home owner, go here.