Article Highlights:
- Definition of a Dwelling Unit
- The Augusta Rule
- Personal Use Days
- Taxpayer Uses It Over 10% of the Rental Days
- Definition of Rental Days
- Definition of Personal-Use Days
- Fix-Up Days
- Allocating Expenses
- Short-Term Rentals
- Room Rentals
- Renting to a Relative
- Fair Rental Value
Owning a dwelling unit that is used as a vacation home can be a dream come true, offering a personal retreat and potential rental income. However, the tax implications of renting out a vacation home can be complex. Understanding these rules can help you maximize your financial benefits and avoid costly mistakes. This article will cover various tax issues associated with vacation home rentals, including the Augusta rule, personal use days, rented 14 days or less, taxpayer using it over 10% of the rental days, allocating expenses, room rentals, fix-up days, renting to a relative, definition of a dwelling unit, definition of rental days, personal-use days, and fair rental value.
- Definition of a Dwelling Unit – For tax purposes, a dwelling unit is defined as a property that provides basic living accommodations, including sleeping space, toilet, and cooking facilities. This includes homes, apartments, condos, mobile homes, boats, and motor homes. A single structure may contain more than one dwelling unit. If you rent out a portion of your home that does not have its own facilities, the rental may be considered part of the main dwelling unit.
- The Augusta Rule – The Augusta Rule allows homeowners to rent out their homes for up to 14 days per year without having to report the rental income. This rule was nicknamed after the Georgia city of Augusta, location of the Masters Tournament, where residents rented out their homes during the prestigious annual golf tournament. Under this rule, which is based on a section of the Internal Revenue Code, if you rent your vacation home for 14 days or fewer in a year, the rental income is tax-free. However, you cannot deduct any rental-related expenses. You can still deduct mortgage interest and property taxes as itemized deductions on Schedule A.
- Taxpayer Uses It Over 10% of the Rental Days – If you rent your vacation home for more than 14 days and your personal use exceeds the greater of 14 days or 10% of the rental days, the property is considered a personal residence. In this case, you must allocate expenses between personal and rental use. You can only deduct rental expenses up to the amount of rental income. Any excess expenses cannot be deducted but can be carried forward to future years.
- Definition of Rental Days – Rental days are days when the property is rented at fair rental value. This includes days when the property is rented to unrelated parties or to relatives at fair rental value. Rental days do not include days when the property is used for personal purposes or days when the property is available for rent but not actually rented.
- Definition of Personal-Use Days – Personal-use days are days when you or your family use the property for personal purposes. This includes days when the property is used by relatives or friends who pay less than fair rental value.
- Fix-Up Days – Fix-up days are days when you spend time repairing or maintaining your vacation home. These days do not count as personal use days, even if you stay overnight. However, the IRS requires that the primary purpose of your stay must be to perform repairs or maintenance. If you spend more time on personal activities than on repairs, the days will be considered personal use days.
However, if the work being done on the home is an improvement rather than just repairing or maintaining it, the time you spend at the property is not fix-up days and would be considered personal days. For example, if you spent 3 months at your vacation home supervising the addition of another bedroom, the days you are there are considered personal use days.
- Allocating Expenses – When you rent out your vacation home, you must allocate expenses between personal and rental use. Expenses that must be allocated include mortgage interest, property taxes, insurance, utilities, and maintenance. The allocation is based on the number of days the property is used for personal purposes versus rental purposes. For example, if you rent your home for 80 days and use it personally for 20 days, 20% of the expenses are allocated to personal use, and 80% are allocated to rental use.
- Short-Term Rentals – Short-term rentals, such as those arranged through Airbnb, VRBO, or similar online marketplaces, can complicate the tax treatment of your vacation home. If you rent your property for short periods, you may be subject to special taxation rules. In some cases, the rental income and expenses must be reported on Form 1040’s Schedule C (generally used by sole proprietors operating a business), rather than Schedule E (the form where rental of real property is usually reported). This can result in self-employment taxes and different expense limitations. Additionally, short-term rentals may be subject to local occupancy taxes and regulations.
- Room Rentals – If you rent out a room in your home, the rental income is taxable, and you must allocate expenses between personal and rental use. The allocation generally is based on the square footage of the rented area compared to the total square footage of the home. For example, if you rent out a 200-square-foot room in a 2,000-square-foot home, 10% of the expenses are allocated to rental use. Alternatively, the allocation can be determined using the number of rooms in the home. You can deduct rental expenses up to the amount of rental income. Any excess expenses can be carried forward to future years.
- Renting to a Relative – If you rent your home to a relative, the rental income is taxable, and you must allocate expenses between personal and rental use. However, if you charge less than fair rental value, the days will be considered personal use days. This can affect the allocation of expenses and the deductibility of losses. To avoid this issue, make sure to charge fair rental value when renting to relatives.
- Fair Rental Value – Fair rental value is the amount you could reasonably expect to receive for renting your property on the open market. This value is determined by factors such as location, size, condition, and amenities. Charging fair rental value is crucial when renting to relatives to avoid having the days classified as personal use days.
Renting out a vacation home can provide valuable income and help offset the costs of ownership. However, the tax rules surrounding vacation home rentals are complex and require careful consideration. Understanding the Augusta rule, personal use days, rented 14 days or less, and the other issues covered in this article can help you navigate these rules and maximize your financial benefits.
If you have questions or need assistance, please consult with this office to ensure compliance with IRS regulations and to make the most of your vacation home rental.
If you have any questions, please contact our office at (503) 224-5321. Isler Northwest LLC is a firm of business advisors and CPAs in Portland, Oregon. Our service goal at Isler Northwest is to earn our clients’ trust as their primary business and financial advisor.
Isler Northwest
(503) 224-5321
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Suite 2900
Portland, Oregon 97201
