What are the tax rules for vacation rentals?

 First let’s define what a vacation rental is.  It is receiving rental income from a dwelling unit such as a house, apartment, condo, house boat, or any other type of residential building.  If you receive income for the use of the property, you can also deduct certain expenses.  Expenses may include mortgage interest, real estate taxes, casualty losses, repairs and maintenance, association dues, advertising, cleaning, pest control, lawn maintenance, realtor management fees, utilities, insurance, and depreciation.  This activity is generally reported on Schedule E, Supplemental Income and Loss, as part of Form 1040.

Of course, it is never that simple.  In a vacation home, you rent it to outside third parties for fair market value rent, but you also use it personally, let family use it for free, let friends use it for a fraction of what you rent to third parties or you even have an agreement with someone to trade dwellings for your vacation.  Each of these situations brings caution.  The reason is that if the property is not rented at a fair market value rent, then that is considered personal use (as if you used it yourself) and there can be limitations on the amount of expenses you can deduct against the rental income depending on the amount of personal use.

If you rent the property to others and your personal use (or deemed personal use by having family or friends use it) is greater than 14 days or 10% of the total days you rent it to others at a fair market price, then your expenses can be limited.  In this situation, you have to allocate the expenses between the personal use days and the rental days.  You also will not be able to deduct your expenses in excess of the gross rental income (i.e. create a loss).  However, if the rental expenses exceed the income, the excess expenses (i.e. rental loss) will carry forward to a future year.  Keep in mind that the portion of mortgage interest and real estate taxes that is related to your personal use of the property will still be deductible as an itemized deduction, assuming you are able to itemize.

Special note:  If you rent the property for less than 15 days (meaning 14 days or less), then you do not have to report the rental income, but you also do not report any of the expenses (except mortgage interest and real estate taxes as an itemized deduction).  However, if you rent your home or home office to your employer for you to work there, then you must report the full rental income even if it is less than 15 days.

This special rule can be handy to some people who even rent out their personal residence for two weeks and pocket the money without paying taxes.

Keep in mind that this article focuses only on the rental of a second home or vacation property.  There are different tax issues or considerations if this property is a full-time rental whether you rent it for 6 months or longer (long-term rental) or 6 months or less (short-term rental).