A Comprehensive Guide to Vacation Rental Tax Rules

Ines Zemelman, EA

• 14.12.21 • 5 min read

Investing in a vacation house might be an attractive proposition. What better way to assure that you'll always be able to return to a destination you've always wanted to visit, while also making some money? More and more people are renting their homes through Airbnb and other vacation rental firms, and they are learning about new tax difficulties that come with this.

However, the tax consequences of having a vacation house will vary based on the owner's use and the frequency with which the property is rented out. Let's take a closer look at how owning a vacation home may affect income tax so that you are familiar with the vacation rental tax rules, vocational rental tax benefits, and deductions.

For those who rent out their home or a portion of their property for a short period of time, there are ways to reduce or eliminate your income tax bill. This means becoming familiar with the tax forms.

Vacation rental property: Tax forms

You can deduct some expenses if you get rental income for the use of a residence, such as a house or an apartment. There are a number of factors that can affect the amount of rental income that is taxed. This information is usually reported on Form 1040, U.S. Individual Income Tax Return or Form 1040-SR, U.S. Tax Return for Seniors and on Schedule E (Form 1040), Supplemental Income and Loss.

Your deductible rental expenses may exceed your gross rental revenue if you're renting to make money and don't use the property as a primary residence.

Tax write-offs for vacation homes

While your short-term rental business may already be profitable, there's still a possibility for growth by taking advantage of tax write-offs. Whether you're a first-time landlord or a seasoned veteran, the advice in the following paragraphs will help you get the most out of your vacation rental property tax write-offs.

1. Property Depreciation. Depreciation can either be a blessing or a pain for short-term rental owners, depending on the situation. If you put your property up for rent in the first year, you can begin taking deductions for property depreciation right away. Because land does not depreciate, the sort of property you own has a significant impact on how much you may deduct on your tax return.
2. Improvement Depreciation. 

   Despite the fact that owners appreciate the ability to write off property depreciation, they may be surprised when some acquisitions and renovations must be written off over an extended period of time.

   During tax season, what will this mean? You may not be able to write off the entire expense of a renovation during the year you paid for it. It's possible that you'll have to spread out your deductions across several years, if not decades.

   Because the laws governing these types of write-offs are complex and subject to change, it's wise to speak with a tax specialist before embarking on a large-scale home renovation project.

3. Personal and Rental Items. Property owners who use their properties for both personal and rental purposes often overlook deductions. Small weekly purchases, such as toilet paper, towels, or soap, can quickly mount up to a considerable annual bill. Since many do not maintain a running total of these fees, they wonder if they can deduct these costs.

4. Insurance and Fees. 

   In addition, property owners fail to deduct certain fees and insurance costs from their taxable income. These expenses, which include HOA fees, legal fees, landlord insurance, homeowners insurance, flood insurance, and more, can be overwhelming to keep track of.

   Just keep in mind that you can only deduct the expense of insurance for the specific tax year, even if you pay for several years' worth in advance.

5. Small Expenses. Rental property owners are sometimes distracted by greater deductions rather than focusing on the dozens of little expenses that are part of running a successful rental business. Advertisement, travel, lawn care, cable, internet, utilities, washing machines, and pool service are all examples of these kinds of expenses that may be incurred and can be written off.

Mixed/Personal use by owner and tenant

In some cases, you may buy a home where you live for part of the year and rent out the rest. Consider dividing your spending between personal and rental use if you need to do so. In the case of vacation houses, the rules you must observe are referred to as "vacation-home rules" and understanding the usage of the property is as important as paying the taxes.

1. Home used mostly by the Owner. If you live in the house as your primary residence and only rent it out for less than 15 days a year, you do not have to declare the income. However, rental charges cannot be deducted. Homeowners, however, are eligible for the regular deductions including mortgage interest, real-estate taxes and casualty losses.
2. Mixed use by Tenant and Owner. 

   Rental revenue is reported on Schedule E if the home is rented for more than 15 days at a time. Expenses can be deducted, but you'll have to prorate them and there may be a cap on how much you can deduct.

   If you're renting out your home, you can't deduct more than the rental revenue. If the property is not your primary residence, you may be able to deduct more expenses than rental revenue. However, the passive-activity regulations would minimize your losses.

A house must meet these two criteria in order to be classified as a residence:

1. It must be able to accommodate a minimum of essential necessities. Hence, sleeping quarters, restrooms, and kitchens are required. Residential property may fall within one of these categories:

2. If it's for personal use, it must meet the time limit. If you utilize your house for more than one of the following objectives, it is regarded as your primary place of residence.

3. Personal Use. Your personal usage of a residence includes the following:

1. An individual who owns a stake in the property. Under a shared equity financing deal, however, this is not true.
2. A member of the family who owns a stake in the property. This is true unless the family member utilizes the home as their primary residence and pays a fair rental value.
3. Those who rent the property for less than the market rate. This does not apply for an employee who uses the home as accommodation at the owner's/discretion.
4. Anyone who stays in the house as part of a home-exchange agreement with the owner. It makes no difference whether the use is for free or for a fee. A tenant paying a fair rental price may permit the owner to reside in the house. If this is the case, the time is considered personal usage when determining whether the dwelling is a home. The period is counted as rented use for calculating the ratio for prorating expenses.
5. It doesn't count as personal use time if you spend time at the house fixing and maintaining it.

Deductions

Consider deducting the following vacation rental expenses when preparing your tax return.

1. Maintenance, repairs, and cleaning
2. Travel expenses incurred for maintenance and management
3. Insurance
4. Taxes and Utilities
5. Advertising and Marketing
6. Accounting Fees
7. Basic Supplies such as towels and sheets
8. Legal Fees

Conclusion

The idea of owning a vacation home could be enticing. Renting out a house via Airbnb or another holiday rental service is becoming increasingly popular, and as a result, more people are becoming aware of the potential tax implications. While there are several expenses and vacation rental tax laws to consider while running a vacation rental business, you can be confident that there are strategies to reduce your taxable income.