The Internal Revenue Code is clear that if you rent a vacation home for less than 15 days, the income and expense is not reportable at all. If you rent the home more than 14 days, you must report the income and expense and the expense must be allocated according to a ratio of rental days divided by total use days. You cannot deduct the portion attributable to personal use as a vacation rental expense.
Additionally, if you must report the income per the rule above and you use the home more than the greater of 14 days or 10% of fair rental days, the house is considered a personal residence. The allocated expenses are used to offset the income but no further. Unused losses are deductible in future years if there is net rental income on the home. Further, allocated expenses must be used in the following order: (1) interest and taxes, (2) operating costs, (3) depreciation.
If the house is used less than 14 days personally, and rented more than 14 days, you have to report income and expense. If there is a loss you will be allowed to write it off against other income currently. However, for those with income over $150,000 those losses may be “suspended” under the Passive Activity Loss rules. If the losses are suspended, they will only be allowed against passive income in future years (usually rental income) or when the rental home is disposed of in a taxable transaction.
Bob uses his vacation house for 16 days during the year. He also rents it for 180 days to unrelated parties. Since 10% of 180 is 18 days, and 18 is more than 16, the property is considered a rental property and he must report all the income and some of the expense according to rental days/total use days (i.e. 180/198 or about 91%). A loss is potentially deductible against other income, and if not it is carried forward until the property is disposed of. If Bob only rented the property for only 150 days, the rules in the second paragraph would apply.
If you own a vacation home, and occasionally rent it out it’s worth a few minutes of discussion with your tax advisor. Feel free to contact us if you have any questions!