You must consider the vacation home rules when you
- rent a bedroom in your home and also use it personally, or
- rent your beach home (or any other home you own) and also use it personally.
Personal Use of the Dwelling
Rent or use by relatives. Personal use includes more than meets the eye. You have personal use of a dwelling when you rent to or allow use by a relative. The rent charged makes no difference.
Paying and non-paying relatives who use your vacation home complicate your deductions. Such use by your relatives is personal use by you. The relatives who come with this personal-use taint include your
- mom and dad,
- brothers and sisters (whole and half),
- sons and daughters,
- grandchildren and grandparents, and
Planning tip. Do not rent to the tainted relatives.
Co-owners must count both use by their relatives and use by themselves as personal use. Thus, if you own a rental home with others, make sure you know about the personal use by the co-owners and also use by their tainted relatives.
Charitable donations produce personal use. No matter how much the charitable donor pays for use of your dwelling unit, the IRS counts the charitable use as personal use by you.
If you donate a week of vacation-home use to your school’s annual auction, you have a week of personal use. It makes no difference what the successful bidder pays for that week of use.
Double whammy. Your charitable gift of the right to use your dwelling unit for the week does not produce a deductible contribution for you. The IRS regulations deny a charitable contribution deduction for a gift of the right to use property.
Thus, the charitable gift penalizes you twice. First, the days you donate are days of personal use by you. Second, your donation of the days does not create a charitable deduction for you.
Swaps produce personal use. Similarly, you have personal use when you swap dwelling units with a friend or under an exchange agreement. Swaps and bargains produce personal days. You count as personal use of your dwelling unit any days that you
- allow a person to use your unit under an agreement that lets you use another dwelling, whether or not you charge rent; or
- charge less than fair rent.
Example 1. You and Nelson swap one week of vacation-home use. Nelson’s use of your dwelling unit during the one-week swap counts as personal use by you.
Example 2. You and Johnson rent each other’s mountain homes for a week at fair market rent. Johnson’s rental of your dwelling unit during that one week counts as personal use by you.
Example 3. You charge your child’s favorite teacher only 67 percent of the fair rent to use your beach home for a week. The teacher’s use of the beach home counts as personal use by you.
Repair days do not produce personal use. Tax law says that you do not use your dwelling unit on days when your principal purpose for such use is repair or maintenance. To qualify the day as a repair day, you must work substantially full-time repairing or maintaining the dwelling unit.
Example 4. You and your spouse arrive Thursday evening at your lakeside cottage after a long drive, but in time for a late dinner at the cottage. You spend a normal workday on both Friday and Saturday getting the unit ready for rental. Your spouse does no work on the house and simply relaxes at the beach.
You depart Sunday, a little before noon. According to the IRS’s examples, your principal purpose for that trip is maintenance. You do not count Thursday, Friday, Saturday, or Sunday as days of personal use. The repair days are non-use days.
Example 5. You own a mountain cabin that you rent in the summers. You spend a week at the cabin with your family. The family members work substantially full-time repairing the cabin. You spend about three to four hours each day during that week helping, and the rest of the time fishing, hiking, and relaxing. According to the IRS, your family’s principal purpose of that week’s stay is maintenance; therefore, the days are not days of personal use.
Again, the repair days are non-use days.
Rented Fewer Than 15 Days
Tax-free income. If you rent your dwelling for fewer than 15 days, you do not report the rental income or any rental expenses on your tax return. The income is tax-free. You do not share it with the government.
Planning tip. Do you have an event coming to your area that might command high rents? Examples include a major golf tournament, Olympic event, or other activity that could allow you to rent at a high rate for a short period.
Say you have a summer home on the beach next to a major golf tournament. You rent the home for $10,000 a week for two weeks. You have $20,000 of tax-free income.
Personal Residence or Rental?
The amount of personal use determines how you will treat your tax deductions on the dwelling. You have a tax code-defined rental of the dwelling when your personal use is either
- 14 days or less, or
- 10 percent or less of the days rented.
Example 6—rental. You rent your resort home 260 days. You use it personally for 26 days. Ten percent of your resort home is a personal home. Ninety percent is a rental property.
Example 7—hobby rental. With 30 days of personal use of the resort home in example 6, you have a residence. Your deductions on the rental part during the current tax year may not exceed your rental income (i.e., you have no tax shelter possibility).
Excess deductions carried forward. When the law deems your dwelling a residence, the deductions attributable to the rental are limited to gross rental income. The good news is that you carry forward the deductions in excess of the gross income limit to next year.
Treatment as a Rental Property
If, based on your rental and personal use, tax law classes your summer home as a rental property, you should follow the IRS allocation method to get the best tax breaks.
Personal part of interest lost. If tax law classes your dwelling as a rental property, any mortgage interest allocated to your personal use is non-deductible consumer interest (ouch!).
Passive loss rules. The dwelling classified as a rental property faces the passive loss rules.
Seven-day rule. The dwelling that is a rental under the 14 days and 10 percent tests is not rental real estate under the passive loss rules if the average rental period during the year is seven days or less, as we explain in Know These Tax Rules If Your Average Rental Is Seven Days or Less.
Rank-and-file employees use the gym 235 days during the year and you, the business owner, use it 137 days. The gym passes the 51-49 test; accordingly, it’s deductible as an employee recreational facility.
As you can see, there’s much to know about vacation homes. If you would like me to help you make sure you have the rules in hand, feel free to contact me by scheduling a call, or by emailing at email@example.com.
We specialize in helping clients clarify their taxes so they keep more of their money. Many small business owners who come to see us in Fort Worth, TX generally do not understand the tax law enough to explain it to a fifth grader.