Do you own or plan to buy a second home? Many vacation homeowners recoup some of the cost of owning that home by renting it out when not using it. This is a great strategy, but it has a number of financial and tax implications. And for the large part, these implications begin on a specific day. What is this day? How does it affect your finances? And how can you make the best decision about it? Here's what you need to know.
What Is the 14-Day Rule for Rentals?
The IRS has specific rules for using the income and expenses from a rental home on your taxes. If you use the home as a personal residence, you may also rent it out for up to 14 days each tax year without tax consequences. However, once you rent it out for 15 or more days, it is partially treated as a rental business. Income is reported and expenses are deducted.
How Do Taxes Change on Day 15?
To understand the tax changes on day 15, start by understanding how the second property is reported when you don't have to report the rental income. In most ways, this property is treated the same as your primary residence. You may deduct property taxes (to a limit), depreciation, other taxes, and mortgage interest.
As mentioned, then, all income the vacation home produces becomes taxable after 14 days of rental use. Depending on how much you can rent it for, this may add significant taxable income. However, you do now get to offset that income by deducting many more expenses related to the property. This includes things like utilities, repairs, updates, and management fees.
In addition, it's not uncommon for rental units to create a loss for tax purposes at the end of the year. This occurs when you have more deductions for allowable expenses than you do reportable income. You may use losses to offset certain other income and lower your taxes in the current or future years.
The downside to these tax benefits, though, is more complicated income taxes. You must track expenses, keep records, and provide backup documentation. There are additional income tax forms, both at the state and federal levels. And you'll generally need to calculate overhead costs based on the percentage of personal and rental use.
Where Should You Start?
Day 15 of rental use for your vacation property is a pivotal day. Should you keep your rental period under this threshold? Or would it benefit you to earn more and take advantage of rental income and expense rules? Find out by meeting with a local accountant who works with taxes in your state today.
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