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How does my short term rental affect my income taxes?

Income taxes can be a complicated issue for vacation rentals. Before we get into the details, it is important to note that most vacation rentals do not have taxable income. Renting a property on a short-term basis, for most owners, is intended to offset the mortgage costs or other costs of ownership. Even if you are ‘cash flow’ break-even or ‘cash flow’ positive you may deduct depreciation expense that can put you in a loss position for income taxes. So for most people there is no income tax owed on their vacation rental, but IRS rules typically limit or eliminate the amount of losses and deductions you can use to offset your other income sources, such as wages and investments.

As a general rule, for income tax purposes you will be required to report rental income from your vacation rental but you can also deduct your expenses, such as mortgage interest, real estate taxes, cleaning/maintenance, insurance, utilities and more. However, special rules govern the amount of expenses you can deduct. These rules are based on how much you rent the home versus home much you use it personally.

Below is a summary of the basic rules that will cover most vacation rental situations:

  • Renting 14 days or less per year. If you rent 14 days or less per year you are not required to report the income on your tax return, so it is completely not taxable. This is a great benefit but very few vacation rentals fall into this category. This would be a timeshare owner, or owner that rents for certain events (Super Bowl, music festival, convention, events, etc.) or only rents during one or two peak rental weeks per year.
  • Vacation home is a full-time rental. If the home is a full-time investment property then you are required to report all rent income but you can also deduct all the expenses on the home. To qualify for this category you need to use the home less than 14 days per year or 10% of the days rented. If your property qualifies as a full-time rental then your expenses may exceed your revenue resulting in a loss. However, this type of loss is considered by the IRS to be passive activity and can only be utilized to offset passive income, not ordinary income such as wages and investment income. Thus, most owners will not be able to utilize these losses to offset other sources of income.
  • Vacation home is a rental but also used personally. If you use the rental property more than 14 days per year and rent it, you are required to allocate your expenses between your rental activity and personal use. Under this category your expenses are not allowed to exceed your rental income (although you can carry these losses forward).
    Basic example of allocating expenses between rental and personal use:
    Days Used Personally:30 25% of expenses are personal
    Days Rented:90 75% of expenses can be used to reduce rental income
    Total Days Utilized:120

In all of these scenarios your rental income and expense will be reported on Schedule E of your personal 1040 return. Any amount that are you are allowed to deduct for personal use of the property will be reported as a standard deduction on Schedule A of your 1040. Also, if you have a ‘single member’ LLC this activity will also be reported on Schedule E of your personal Form 1040, versus filing a separate tax return for your LLC.

State Income Tax Filing

Renting a property in most states is a business activity and will trigger the requirement to file a state income tax return in the state where your rental is located. The income and loss related to your rental property should be reported in the state where the property is located and not the state where you reside.

Are you registered, licensed and collecting the right tax? Being wrong is expensive.

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