As a vacation rental owner nearing the upcoming tax season, your thoughts are probably on how to make the most of your tax deductions this year—as well as plan ahead for next year.
We spoke with several tax experts who specialize in vacation rentals to uncover some of the biggest saving strategies, starting with the basics and also including some lesser known write-offs that can save you money.
Know the personal use rules
“The magic number is 14,” says Crystal Stranger, president of 1st Tax and the author of The Small Business Tax Guide.
If you use your rental house for more than 14 days per year or more than 10 percent of the time rented to others, then it is considered a personal residence. You must divide your total expenses between the rental portion and the personal use, she says.
On the other hand, “if you rent your house for 14 days or less, then it is considered fully personal use and you do not include rental income at all,” says Stranger.
Here’s how to divide up your expenses between personal use days and rental days, using an example from Steven M. Packer, CPA and senior manager of Tax Accounting Group at Duane Morris LLP in Philadelphia:
“For example, if the house is rented for 90 days and used personally for 30 days, then 75 percent of the use is rental (90 days out of 120 total days of use). You would allocate 75 percent of your maintenance, utilities, insurance, etc., costs to rental. You would allocate 75 percent of your depreciation allowance, interest, and taxes for the property to rental, as well. The personal use portion of taxes is separately deductible. The personal use portion of interest on a second home is also deductible where (as is the case here) the personal use exceeds the greater of 14 days or 10 percent of the rental days. However, depreciation on the personal use portion isn’t allowed.”
Understand what to do if your rental income exceeds allowable deductions
You can deduct part of your operating expenses and depreciation, says Packer, subject to these rules:
“If the rental income exceeds these allowable deductions, then you report the rent and deductions to determine the amount of rental income to add to your other income. If the expenses exceed the income you may be able to claim a rental loss. This depends on how many days you use the house for personal purposes,” he says.
Here’s the test: if you use it personally for more than the greater of (a) 14 days or (b) 10 percent of the rental days, you are using it too much, and you cannot claim your loss, he says. In this case, you can still use your deductions to wipe out the rental income, but you cannot go beyond the income to create a loss. Any deductions you cannot use are carried forward and may be usable in future years. If you are limited to using deductions only up to the amount of rental income, you must use the deductions allocated to the rental portion in the following order: (1) interest and taxes, (2) operating costs, (3) depreciation, says Packer.
“If you pass the personal use test, you must still allocate your expenses between the personal and rental portions,” he says. “In this case, however, if your rental deductions exceed rental income, you can claim the loss. The loss is passive, however, and may be limited under the passive loss rules.”
Another example from Packer: “You rent a vacation home for 60 days and use it personally for 20 days. You are paid rent of $8,000. Expenses are $6,000 in interest and taxes, $3,600 operating costs, and $4,800 depreciation, for a total of $14,400. Personal use is 25 percent (20 out of 80 total use days). So 75 percent of expenses are allocated to rental ($14,400 × 75 percent = $10,800). There is thus a rental loss of $2,800 ($8,000 income, $10,800 expenses). However, personal use (20 days) exceeds the greater of (1) 14 days and (2) 10 percent of rental days (6). The loss is thus disallowed. You can deduct only $8,000 of expenses (up to the rental income). You must first deduct the rental portion (75%) of the interest and taxes ($4,500 (75 percent of $6,000), then 75 percent of the operating costs ($2,700 (75 percent of $3,600), which totals $7,200 ($4,500 plus $2,700). You can then deduct only an additional $800 of depreciation.”
Common rental expenses you can write off
In general, you can claim the deductions for the year in which you pay for these common rental property expenses, according to Cozette White, personal tax expert with My Financial Home Enterprises in Oxnard, California:
- Cleaning and maintenance
- Commissions paid to rental agents
- Homeowner association/condo dues
- Insurance premiums
- Legal fees
- Mortgage interest
Other deductible expenses
Traveling to your rental home. “You can deduct expenses related to traveling locally to a rental home for such activities as showing it, collecting rent, or doing maintenance. If you use your own car, you can claim the standard mileage rate, plus tolls and parking,” says White. For 2016, it’s 54 cents per mile.
Traveling outside your rental home. “Traveling outside your local area to a rental home is another matter,” says White. “You can write off the expenses if the purpose of the trip is to collect rent or, in the words of the IRS, ‘manage, conserve, or maintain’ the property. If you mix business with pleasure during the trip, you can only deduct the portion of expenses that directly relates to rental activities.
Tracking the tax basis in your vacation home
“This means keeping great digital records of any of your home improvement projects, as your tax basis is the purchase price of the home plus the sum of all your home remodeling projects,” says John Bodrozic, cofounder of HomeZada. “When you sell the home, you will use the sales price minus the tax basis to help you compute your taxes. Keeping before and after photos, receipts, warranties, invoices, etc., will keep you prepared for tax season.”