Are you intrigued by renting out your beautiful vacation home in sunny Florida or in the rolling Rockies? Not only can such a residence be a safe haven for you to get away, but it can also serve as a source of passive income by renting it out throughout the year.
If you’re a bit overwhelmed by the tax implications of a vacation home, don’t sweat it. Understanding these 6 concepts can help ease your fears.
1. Understand the IRS’ second home definition.
Where you live most of the year is your primary residence. In IRS lingo, your second home is not your primary place of residence. However, you must use this dwelling personally, and you cannot rent it out for more than 14 days each year to qualify for this designation of a second home.
A second home can be a family-style house, condominium, mobile home, time-share unit, RV, or even a houseboat. Also, such a rental must include sleeping, cooking, and restroom facilities.
2. Frequency of use of a vacation rental impacts your taxes.
There is a critical 14-day rule for all vacation home renters to understand. Thanks to this IRS regulation, you do not have to pay taxes on income you earn from the short-term rental of vacation property you own.
The caveats at play here are that you must rent the home for no more than 14 days within a given year. Plus, you must use this home at least 14 days per year or at least 10% of the total number of days you rent it out to vacationers.
On another note, let’s say you only rent out a single room in your home. In this case, the 14-day rule would also apply to that one room just as it applies to renting out an entire vacation home.
3. Maintain thorough records to claim eligible tax deductions on rentals.
If you rent your second home for 14 days or less in a year, be sure to keep solid records of the days on which visitors stay there and the days you occupy the getaway.
If you rent out this residence for 15 days or longer in a year, it’s important to document your personal and business expenses tied to the use of this second home.
You’ll need this detailed information to claim deductions on relevant rental expenses, such as buying new mattresses for the beds or putting up new wallpaper in the living room. Any of these associated expenses are deductible if they are ordinary and necessary to the proper maintenance of your rental home. You may also qualify to write off property taxes and mortgage interest on this second home.
4. You must apportion mortgage interest and taxes when renting one room.
Perhaps you’ve got a spare bedroom that you never use, and you want to earn some extra passive income by renting it out.
By renting out just a single room and not an entire home to your guests, you’re on the hook for paying taxes on the rental rate you specify, and you can deduct rental business expenses tied to this income. But you are not eligible to write off 100% of these relevant costs, such as your property taxes or mortgage interest. Instead, these expenses must be apportioned between the personal and business use of your residence.
5. You may be on the hook for occupancy tax payments.
In certain U.S. states and municipalities, there are occupancy taxes levied on short-term home rentals. Some of these taxes are known as transient lodging taxes and hotel taxes. The rates and rules on them vary greatly, so be aware that wherever your vacation rental is located, there may be additional local or state taxes on the books.
Oftentimes, the owner of a vacation home is responsible for collecting and submitting these occupancy tax payments to the relevant tax authority.
6. You may owe self-employment taxes to the IRS.
If you earn a decent amount of income from renting out a vacation home, the IRS will likely view this passive income as self-employment income that you earn aside from the salary at your W-2 job. As such, you’re likely required to pay self-employment taxes on rental income, which include Social Security and Medicare taxes. Consider establishing an LLC or corporate entity for your vacation home rental income. Doing so can help cut your self-employment tax liability.