What Are the Vacation Rental Tax Rules?

Owning a vacation rental property involves a unique set of tax rules that differ from those for a primary residence. The Internal Revenue Service (IRS) has established guidelines that dictate how income is reported and expenses are deducted. These regulations are tied directly to the number of days the property is rented out versus the number of days it is used for personal purposes.

The way an owner uses their property directly impacts its classification for tax purposes. This classification determines whether rental income is taxable and which expenses are eligible for deduction. Navigating these rules allows owners to meet their tax obligations and manage the financial outcomes of their property.

Classifying Your Property for Tax Purposes

The first step in managing your vacation rental’s taxes is to determine how the IRS views your property. This classification depends on your personal use of the property compared to the number of days you rent it to others at a fair market price. The IRS provides clear tests to categorize your property, which dictates how you report income and expenses.

One category is for properties with minimal rental use. Under the “14-day rule,” if you rent your property for 14 or fewer days during the year, you do not need to report the rental income. This income is tax-free, but you also cannot deduct any rental expenses. Your mortgage interest and property taxes remain deductible as personal expenses on Schedule A of your tax return, subject to standard limitations.

A property is considered a personal residence with hybrid use if you rent it for 15 or more days and your personal use exceeds the greater of either 14 days or 10% of the total days it was rented. For example, if you rented your beach house for 200 days, your personal use would need to exceed 20 days for it to fall into this category. Personal use days include any day the property is used by you, your family, or anyone paying less than a fair rental price.

The final category is for properties treated primarily as a rental property. This classification applies if you rent the property for 15 or more days and your personal use does not exceed the greater of 14 days or 10% of the days it was rented. For instance, if you rented your cabin for 150 days and used it personally for only 12 days, it would be classified as a rental property, which allows for the potential to deduct a net loss.

Calculating Taxable Income and Deductible Expenses

To calculate your net rental income or loss, you must first identify all sources of gross rental income. This figure includes rent from tenants, non-refundable security deposits, cleaning fees, and any other service fees they pay. If a tenant pays for utilities directly to the service provider, that amount is also rental income, though you can then deduct the utility cost as a rental expense.

After totaling your income, you can identify deductible expenses. The IRS allows deductions for “ordinary and necessary” expenses for managing and maintaining your rental property. Common examples include:

• Mortgage interest
• Property taxes
• Insurance premiums
• Repairs and maintenance
• Utilities
• Supplies like linens and toiletries
• Management and advertising fees
• Professional fees for legal or tax services

Travel costs can also be deducted if the primary purpose of your trip is to perform repairs and maintenance.

For properties used as both a rental and a personal residence, you must allocate expenses. The IRS-approved method involves dividing the total number of days the property was rented at a fair price by the total number of days it was used for both rental and personal purposes. For example, if you rented the property for 90 days and used it personally for 30 days, the rental-use percentage would be 75%. You would then multiply your total expenses by this percentage to determine the deductible amount.

Depreciation is another deduction that allows you to recover the cost of the property over its useful life. For residential rental properties, the IRS specifies a recovery period of 27.5 years. The basis for depreciation includes the purchase price of the building, certain closing costs, and the cost of any significant improvements. To calculate the annual depreciation deduction, you divide the property’s basis by 27.5.

Your net rental income may also be subject to the Net Investment Income Tax (NIIT). This is a 3.8% tax that applies to the lesser of your net investment income or the amount by which your modified adjusted gross income exceeds certain thresholds.

Understanding Passive Activity Loss Limitations

If your property has a net loss for the year, your ability to deduct it against other income is subject to specific rules. Rental real estate is considered a “passive activity,” which means losses from these activities are typically only deductible against income from other passive activities. If you do not have any other passive income, your rental losses are suspended and cannot be deducted in the current year.

The IRS allows a special allowance of up to $25,000 in rental real estate losses to be deducted against non-passive income, such as your salary. To qualify for this allowance, you must “actively participate” in the rental activity. Active participation requires making management decisions like approving tenants, setting rental terms, and approving repairs.

This $25,000 special allowance is subject to income limitations. The full deduction is available to taxpayers with a Modified Adjusted Gross Income (MAGI) of $100,000 or less. The allowance is gradually phased out for taxpayers with a MAGI between $100,000 and $150,000, and it is unavailable if your MAGI is above $150,000. Any losses that cannot be deducted are carried forward to future years to offset future passive income or are deducted when you sell the property.

Reporting Vacation Rental Activity to the IRS

The primary form for reporting income and expenses from rental real estate is Schedule E (Supplemental Income and Loss). This form is filed along with your annual Form 1040 tax return, and all your rental income and itemized expenses are detailed on this schedule.

On Schedule E, your gross rental income is reported on Line 3, while your various deductible expenses are itemized on Lines 5 through 19. The total of these expenses is then subtracted from your gross income to determine your net rental income or loss for the year.

If you are claiming depreciation on your property, you must also complete and attach Form 4562, Depreciation and Amortization. This form is used to detail the calculation of your depreciation deduction. The total depreciation amount calculated on Form 4562 is then entered on Line 18 of Schedule E.

After completing all necessary forms, the net income or loss from Schedule E is carried over to your Form 1040. Net rental income will be added to your other income, while a deductible net loss will be used to reduce your total income, subject to the passive activity loss limitations.