Are your customers spending more time in their holiday home this summer? You should know that this can lead to tax complications if you rent out the house intermittently. Let’s start with the basic rules and let’s dig deeper from there.
Basic rules: Rental income from a vacation home is usually taxable, but certain expenses – such as mortgage interest, property taxes, repairs, utilities, insurance, etc. – can be deducted from income. (Depending on the situation, mortgage interest and property taxes can otherwise be deducted in whole or in part from the personal declaration for a qualified residence, subject to other tax law limits).
If their annual rent is only two weeks or less, they do not need to report rental income to the IRS or deduct any billing charges. But it gets a little trickier if you rent the place out for more than 14 days and still use it personally. In this case, you will have to pay tax on all rental income, while you can only deduct part of your expenses.
Significantly, they have to split the cost between days of “business use” and “personal use”. Any day that the house is rented to a stranger at a fair price counts as a business day. Conversely, if you spend a day of R&R at home, it is considered a day for personal use.
example: You rent the holiday home in 2021 for 80 days and the family uses it personally for 20 days. Accordingly, they can deduct 80 percent of their qualified rental expenses (see above) as well as the full costs of a landlord or property manager.
After all, they are entitled to an 80 percent depreciation. If these rental expenses exceed their rental income, they would suffer a tax loss.
But here’s the catch: Since your holiday home is used personally for more than 14 days or 10 percent of the rented days, you cannot deduct any loss when you return it. With that in mind, they could try to stay within the confines of the 14 day / 10 percent rule. Usually they reduced their personal use or rented out the apartment for longer or a combination of both.
Save grace: Every day spent repairing the house does not count as a day for personal use, even if the rest of the family comes along. For example, if they fix a broken screen door while their kids are frolicking on the beach, it is still treated as a business day.
Nevertheless, the customers are not completely out of the woods. According to a special tax law provision, renting a holiday home is treated as a “passive activity”. In general, they can’t claim Passive Loss of Activity (PAL) anyway, although there is a limited exception based on Adjusted Gross Income (AGI).
How it works: If your AGI is less than $ 100,000 and you “actively participate” in the activity, you can use up to $ 25,000 of the vacation rental loss to offset other income. The depreciation is phased out and disappears completely when the AGI exceeds $ 150,000. All unapproved PAL will be suspended and may be used in the future. In this sense, an active participant is someone who is involved in management decisions, sets rental prices, arranges repairs, etc.
In summary: These tax rules are complex. Therefore, sooner or later, contact your customers who own a holiday home.