November 15, 2016
Understanding the Tax Implications of Renting Out Your Vacation Home
The decision to rent out your vacation home can be an extremely challenging one. I spent many hours mulling over the pros and cons of renting out my vacation property, focusing on things like the financials and how it would feel to have a complete stranger staying in my home. Those were the most obvious points. There was one point that I didn’t even think to consider until tax season rolled around: the tax implications of renting out my vacation home. I missed out on thousands of dollars in tax deductions and underestimated how much I needed to pay in taxes. In the end, it hit me where it hurts — my bank account.
With a little education, my experience doesn’t have to be the case for other vacation rental owners. According to research from HomeAway, vacation homeowners rent out their homes an average of 36 of the 52 weeks in a year, pulling in an average income of more than $27,000. That’s not an insignificant amount of money, so it’s vital that you understand your tax liabilities associated with that income.
If you’re thinking of renting out your property, you’ll need to seriously consider how it will impact your taxes. You don’t want to find yourself in a situation in which you’re facing unexpected tax troubles come April 15. So let’s take a peek at how renting a vacation home will affect your taxes.
How Does the Vacation Home’s Use Affect Your Taxes?
Your taxes are affected quite significantly by your vacation property’s use, particularly how much time you spend at the home and how much time renters spend occupying the property. Generally speaking, there are three scenarios that can arise when it comes to how your vacation home is used:
- The property is a full-time rental property that’s occupied by renters for a majority of the year.
- The property is a short-term rental property that’s occupied by renters for a very short period of time each year — typically 14 days or less per year.
- The property is considered a hybrid rental property, with you spending a significant amount of time in the vacation home, while renters occupy the property for a large portion of the time when you’re not present.
These three rental home usage scenarios are linked to some very different tax implications, so let’s explore how each of these vacation home uses will affect your taxes.
Tax Implications for a Full-Time Vacation Rental Property
A vacation home would be considered a full-time rental property if you rent out the property and you personally spend less than 14 days in the home annually, or your time in the home accounts for less than 10% of the total time the property is occupied in a given year.
In the case of a full-time vacation rental, you face the same tax implications that you would face with any other type of investment property. Many of the expenses associated with home are deductible, including repairs, maintenance costs, marketing fees, property management fees, and interest on a home loan.
It’s been reported that about 50% of full-time vacation homeowners with a mortgage on their property were able to cover at least 75% of their mortgage using the money earned from rental fees. So for many, a full-time vacation rental can be a great investment.
Taxation on full-time vacation rentals can get quite complex because real estate rentals are typically considered “passive activities.” Losses from passive activities can usually be used to offset taxes on a passive activity (versus typical income from your job.) So you could use deductions on a passive activity (like a rental property) to reduce the total amount owed in taxes on the rental property income, but you couldn’t use deductions related to your rental home to offset the total amount owed on income taxes from your full-time job (since your full-time job is not considered a passive activity).
But there are some workarounds. For example, in some cases, if you are an “active participant” in your vacation rental and use the property yourself, you could be eligible to deduct up to $25,000 of the property-related expenses on your income taxes from your full-time job. Each case is a bit unique, so it’s really best to consult a tax professional so you can take full advantage to all of the deductions and tax benefits that are available to you.
Tax Implications for a Short-Term Vacation Rental
Short-term vacation rentals typically refer to properties that are rented out for a very short period of time in a year — usually less than two weeks. The profits from a property that is rented for less than 14 days per year are not taxable.
So let’s say you rented your vacation home to Super Bowl fans or convention-goers or others who are seeking to stay in the area for a special event. Whether you earn $5,000 or $50,000, the bottom line is the same: These funds are not taxable, as long as the rental timeframe was less than two weeks in length.
It’s also worth noting that this tax-free, two-week rental tax “freebie” can also be applied to your full-time home — not just your second home.
Tax Implications for a Hybrid Rental Property
A hybrid rental property is one in which you stay more than two weeks per year and also rent it out for more than two weeks per year. With a hybrid rental property, you must keep detailed records to determine what percentage of the time you spend in the vacation home versus how much time renters spend in the property.
Let’s say that you spent 75 days in your vacation home last year. Renters spent a total of 225 days in your rental. So in all, your family accounts for 25% of the occupancy, while renters account for 75% of the vacation home’s occupancy.
Next, you total up all of the deductible property expenses. Then, you subtract 25% from the final figure (this corresponds to the 25% of the time that you spent in the vacation home). In all, 75% of the eligible expenses would be deductible from the taxable rental fees collected.
It’s not possible to claim rental-related losses in this scenario, but it would be theoretically possible to deduct away all of your rental income.
Other Tax Considerations When Renting a Vacation Home
It’s also important to remember to put aside funds to cover additional taxes, including property taxes, local taxes, and state taxes. Each state and region have their own unique taxation systems that can impact vacation rentals.
For example:
- Florida counties impose a tourist impact tax on rental properties.
- Texas vacation rentals that are rented out for less than 30 days are subject to a hotel occupancy tax.
- California charges a transient occupancy tax on vacation rentals.
So remember to research the tax liabilities in your local region. It may be beneficial to consult a local accountant who is familiar with vacation rental properties.
There are lots of points to keep in mind when you make the decision to rent out your vacation home, so be sure to do your research and be realistic. There are some complexities associated with renting a vacation home — complexities and issues that you would not otherwise deal with if you maintained the home exclusively for your own use. So, it’s important to be realistic about whether you’re truly willing to deal with the extra stress — and yes, hassle — that may arise.
If you’re ready to start renting your vacation home, you can really benefit from working with an experienced property management firm, and that’s precisely where Rented.com can help. We’re here to help answer all of your questions related to renting your vacation home and to match you with the perfect property management company for your needs. Call us at +1 (844) 736-8334, chat with us below, or create a free private profile today to get the process started.
Lead image: Flickr CC user vertisincertus
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