There are many complex rules in maximizing tax benefits when dealing with vacation homes. Rachel Alexander, CPA, Tax Manager at Salmon Sims Thomas discusses the rules you need to know in order to successfully amplify tax breaks.
First, here are the most common deductible rental expenses according to the IRS:
- Auto/travel expenses
- Cleaning and maintenance
- Legal/professional fees
- Local transportation expenses
- Management fees
- Mortgage interest paid to banks, etc.
- Rental Payments
Vacation homes are primarily involved in three situations. Understanding all three will allow you to maximize your tax benefits.
- The home is used personally for most of the year. If the home is rented for two weeks or less, you cannot claim any deductions. But remember that you don’t have to pay tax on rental income either. Owners may cash in under the rules for short-term rentals. A short-term rental may arise when of an important event is taking place.
- The home use is split between renters and owners. This is the most complicated out of the three scenarios, but it doesn’t have to be challenging. Generally, rental income is taxable but expenses are deductible only up to certain limits. These limitations are included in the list above. If vacation homeowners can keep personal use below the 14-day or 10 percent threshold, the owner may be able to claim a loss, subject to the “Passive activity loss” (PAL) restrictions.
In addition, if personal use exceeds the threshold you must subtract the personal portion of your expenses. This includes mortgage interest and property taxes. Remember that fixing up the place for the rental season or completing repairs does not count as a “personal use” day.
- The home is rented out for the entirety of the year. In this case, any rental income received is taxable, but expenses are typically deductible against the income. The home can be looked at as a strong investment for tax purposes. The owner may be entitled to a tax loss as long as the family’s personal use does not exceed the 14 days or 10 percent of the time the home is rented out.
Under PAL rules, the annual loss is generally limited to the amount of annual income from other passive activities. A $25,000 balance for rental real estate activity is available to active participants. However, the limited tax break is not an option for someone with an adjusted gross income that is between $100,000 and $150,000.