With the looming April 15 tax deadline, vacation rental property owners across the country are trying to get to the bottom of one important tax question: Can rental income loss be deducted?
Sure, practiced accountants know the answer, but for those without experience in the tax industry, figuring out whether or not vacation rental income loss can be deducted is far from easy. That’s why we’re breaking it down in layman’s terms, helping you understand what rental property owners can and can’t deduct for tax season 2020.
First things first: Can rental income loss be deducted?
In short, yes, rental home income loss can be deducted—but there are stipulations based on the tax filer’s role with the property.
“You may be able to deduct rental income losses up to $25,000 if you actively participate in your rental when rental expenses like utilities, property taxes, and associated mortgage loan interest exceed the gross rental income,” said Lisa Greene-Lewis, CPA and TurboTax expert. “However, losses are limited to the passive activity loss rules for non-real estate professionals.”
The IRS’ passive activity loss rules were designed to prohibit taxpayers from using passive losses to offset ordinary earned income. Passive losses can only be used to offset passive income, according to Investopedia.
Which rental home expenses can I deduct?
According to the IRS, rental home owners can deduct mortgage interest, property tax, operating expenses, depreciation, and repairs. Greene-Lewis also reminds property owners not to overlook some of the more common yet forgotten expenses, such as advertising, cleaning and maintenance, pest control, repairs, and service fees charged by Airbnb or HomeAway.
That said, some expenses cannot be deducted.
“You may not deduct the cost of improvements,” according to the IRS website on rental real estate income. “A rental property is improved only if the amounts paid are for a betterment or restoration or adaptation to a new or different use.”
What counts as rental property income?
The IRS states that rental property owners must include the gross income of all amounts received as rent, which basically includes any and all income a property owner has received through their home. There is one caveat, though: security deposits.
“Do not include a security deposit in your income when you receive it if you plan to return it to your tenant at the end of the lease,” according to the IRS website. “But, if you keep part or all of the security deposit during any year because your tenant does not live up to the terms of the lease, include the amount you keep in your income in that year.”
Do I have to report my vacation rental home income?
If your property was rented for less than 14 days or less, you actually don’t have to report the income, according to Greene-Lewis. But, if you go this route, you’re also not allowed to take expenses related to the income or claim a rental loss.
This rule only applies for properties rented for 14 days or less. Anything beyond this number requires you to report your rental income on your tax return (which also means you can deduct your rental income loss).
Be ready for local short-term occupancy taxes
While federal taxes are the focus, Greene-Lewis notes that many rental owners get surprised by tax letters from their local tax authorities. These taxes have different names depending on the city—some call them occupancy tax while others say tourism tax—but one thing’s for certain: They can’t be ignored.
“Some state and local governments impose occupancy taxes on short-term rentals,” said Greene-Lewis. “These vary widely from one jurisdiction to the next, from the name of the tax (hotel tax in some states, transient lodging in others) to the rates and rules. In many cases, the host is required to collect the occupancy tax directly from renters and submit the money to the tax authority.”
Keep reliable records
Like all businesses, running a vacation rental property requires detailed documentation for income and expenses. The IRS urges property owners to keep concrete evidence such as receipts, canceled checks, bills, etc.
According to Greene-Lewis, it’s also smart to keep records of any contractors you’ve paid over $600 in the tax year. “Keep each contractor’s tax ID number, especially if they are unincorporated, and submit the amount you paid them on IRS form 1099-MISC,” Greene-Lewis said. “Having a W9 on file for each contractor used makes it easier at the end of the year.”
Ready to tackle taxes head on? For additional resources to make tax season manageable—plus an important overview of the 2020 tax law changes—check out our guide with 6 tax tips for vacation rental homeowners.