According to Redfin, second home sales in the United States jumped 70 percent in October 2021 from pre-pandemic levels, recording another strong month in the year. The popularity of vacation or second homes has grown exponentially during the pandemic fueled by low mortgage interest rates and the ability to work from home.
Taxpayers acquire second homes for various purposes, such as personal getaways, renting them out until retirement or mixed-use (rental and personal use).
Taxpayers who use their second home as both a rental and personal use (mixed use property) will find that applying the tax laws can be complicated. Renting your second or vacation home can result in different tax consequences depending on the number of days in the calendar year your vacation home is used for rental purposes as opposed to personal use.
Any day in which the vacation home is rented at fair market value is a rental day unless it is a family member who does not live there full-time (see exception below).
Personal use means use by the owner or family members for any day in the year. If the vacation home is rented at fair market rental rate to a family member and the home was used as that family member’s principal residence, then no personal use is attributable to the owner. If another person uses the vacation home at less than fair rental value, including donated use for charity, then those days are counted as personal use attributed to the owner.
Any day in which you spend substantially full time repairing and maintaining your vacation home is not counted as a day of personal use.
For tax reporting purposes, a vacation home with both personal and rental use in the calendar year is classified in one the following categories:
- Minimal Use: The vacation home is rented at fair market value fewer than 15 days in the calendar year. This special rule exempts the taxpayer from reporting the rental income (regardless of the amount of rental income received) and no deduction is allowed for direct rental expenses. Mortgage interest and property tax are still allowed as Schedule A deductions.
- Rental Property: The vacation home is rented out for more than 14 days in the calendar year and personal use that does not exceed the greater of 14 days, or 10% of the total days the vacation home is rented to others at a fair rental price.
- Personal Residence: The vacation home is rented out for more than 14 days in the calendar year and personal use exceeds the greater of 14 days, or 10% of the total days the vacation home is rented to others at a fair rental price.
If your vacation home meets the rental property designation in the year, you are required to report the rental income and you can deduct expenses related to the rental, such as depreciation, utilities, repairs, and property management fees. Expenses in excess of the rental income (net loss) could be limited under the passive loss rules.
Tax reporting consequences for vacation homes that fall under the category as personal residence become much more complex. The rental income is still reported on Schedule E and the rental expenses, both direct and indirect are subject to allocation between rental and personal use days. However, you may not deduct the allocated rental portion of expenses in excess of rental income. Allocable personal use mortgage interest and property taxes can be deducted on Schedule A, subject to limitations.
Application of the federal income tax rules to vacation homes are complicated and this article only touched on some of the tax consequences that could occur. Please contact your RINA representative for advice on navigating the vacation home rules.