Diane H. Wells, CPA, PC
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Vacation/Rental Home Income & Expenses

 
 

There are limits on the deductibility of expenses if the property rented is a "dwelling unit" and the dwelling unit is used for personal purposes. A "dwelling unit" is a home, apartment, condo, mobile home, boat, or any other structure containing sleeping space, toilet, and cooking facilities.

The type and amount of expenses that you can deduct depend on how often you use the home for personal use and how often you rent it to others. In general, there are two types of expenses associated with a vacation home -- trade or business (or production of income) expenses and deductible personal expenses. Deductible personal expenses are items that are deductible in their entirety, regardless of whether the vacation home is personal use or rental property -- e.g., casualty losses, state and local property taxes, and interest.

The first limitation on the deductibility of expenses is that the expenses related to a trade or business or the production of income -- i.e., rental expenses -- are only deductible to the extent you do not use the home for personal use. Moreover, a second limitation applies if your personal use is so extensive that the dwelling unit is treated as a "residence" for tax purposes. This second limitation prohibits you from deducting any rental expenses that exceed the gross rental income from the property.

One of the first things you must do is determine the number of days during the year that you used the vacation home for personal purposes. In making this determination, any fraction of a day counts as a whole day (even if you just use part of the unit). You may exclude the days that the home was used for repairs and maintenance, as well as the time it was held out for rent. If, however, you use the home for personal purposes on the same day it is rented for fair rental value, you must include it as a personal use day. Fair rental value is the amount of rent an unrelated person would be willing to pay.

In a few cases you must treat someone else's use as your own. Thus, you must count as personal use any day in which the home was used by a co-owner, a family member of you or your co-owner, an individual who is renting for less than fair rental value, or by an individual who is using your house under an arrangement that enables you to use another dwelling unit (e.g., switching a beach house and a mountain cabin). A word of caution. Family members' use counts as your personal use even if they are paying fair rental value (unless they use the home for their primary residence). This is also true for the switching arrangement.

You should next determine the number of days the vacation home was rented for its fair rental value. This number is important both for determining whether the dwelling unit is a residence and for allocating deductions between personal and rental uses. If the number of personal use days exceeds the greater of (1) 14 days or (2) 10% of the number of days the unit was rented at fair rental value, the dwelling unit is a residence and the second limitation on expenses (i.e., the gross income limitation) will apply.

To apply the first limitation on deductibility, you must calculate the allocation fraction. This determines what percent of each expense is attributable to rental use and, therefore, what percent of the expense is deductible. The numerator of the fraction is the number of days the home was rented at fair rental value. There are, however, two views on what constitutes the denominator. The Tax Court and the Ninth Circuit view, which is more favorable to taxpayers, is that the denominator includes all days in the taxable year. The IRS includes in the denominator only the days the property was used for any purpose, and excludes from both the numerator and denominator the days the property was used for repairs and maintenance.

After you have calculated the allocation fraction, multiply it by the items of rental expense. If the second limitation, described below, does not apply, it does not matter if you apply the fraction on an item-by-item basis or to the total of the rental expenses. If the unit is not a residence, the entire amount calculated is deductible.

If the dwelling unit is a residence, the gross income limitation applies. Gross income for purposes of the limitation is: gross rental receipts (even if it was rented for below fair rental value), reduced by deductible personal expenses allocable to the rental unit, and further reduced by the rental expenses not directly related to the dwelling unit itself.

These latter expenses are not allowed at all if you have no profit motive in renting the home. Once you have determined the gross income, apply the allocation fraction to each separate item of rental expense. If the total of these expenses exceed gross income, special ordering rules apply and some items will be disallowed in the current taxable year. Any excess is carried over to the following year. These expenses, however, will still be subject to the gross income limitation in following years, even if the property is no longer a "residence."

Any deductible personal expenses not deducted because of the gross income limitation are allowed as itemized deductions.

I hope you have found this information helpful in explaining the complex rules relating to vacation rental home expenses. If you have any questions, please feel free to call me.