Vacation Home Rental Tax Treatment and Other Considerations
A vacation home, be it a cabin, lake house, or a warm-weather escape from harsh winters, can be a great asset for your family to use and enjoy. These second homes are so often where we gather with loved ones and spend our holidays making memories. In our increasingly connected world, turning a second home into an income source has become a much simpler process. Internet accommodation sites such as VRBO, Airbnb, and the like have bridged the gap between property owners and accommodation seekers. We live in a much different world than we did even 15 years ago. Airbnb, the world’s largest accommodation provider, owns no real estate. The accommodations offered are provided by individuals and families with these properties that they are leaving vacant for some amount of time.
Second Home Rental Considerations & Liability Insurance
It is important to understand the protections offered through the service you choose to protect your property from damage, and to gauge if you are comfortable with allowing renters to make use of your property. Your homeowner’s insurance may not cover personal liability when it comes to home sharing. Services such as Airbnb offer Host Protection Insurance that can cover up to $1,000,000 in primary liability insurance. Additionally, many major insurance providers offer similar host protection insurance that can supplement your current homeowner’s insurance. Another way to protect yourself is to form an LLC around your rental to limit your personal liability.
It is of great importance to understand the tax implications of allowing renters in your second home. In the world of personal income tax, a residence used for personal vacations and also rented to unrelated people is categorized as a mixed-use asset. These mixed-use assets fall into one of three categories.
- Your property is considered a “personal residence” if it is rented to unrelated parties for a total of 14 days or fewer in a year, or if the amount of days it is rented out equals 10% or less of the amount of days that it is used by yourself.
- If the property is used personally in a year for more than 14 days or it is personally used for an amount of days that is greater than 10% of the days that you rent it to unrelated parties, it is considered a “vacation home”.
- A residence is considered a “rental property” if it is used personally less than or equal to 14 days, or less than or equal to 10% of the days rented.
What does all of this mean from a tax perspective?
If your property falls into the “personal residence” category, you are not required to report any rental income and no deduction for rental expenses related to the home are allowed. If the property is categorized as a vacation home, you must report the income made from renting to the unrelated parties, and you are allowed to allocate expenses related to the home based on the number of days rented compared to the number of days it is used personally. Examples of common deductible expenses include, but are not limited to mortgage interest, repairs, and insurance. With respect to a vacation home, reporting a net loss is not allowed. If a home falls into the category of a “rental property”, much like the tax treatment of a vacation home, one must report the income from the rental, and expenses are allocated based on the number of days rented compared to the number of days used personally. The key difference between a vacation home and a rental property is that when you own a rental property, you are allowed to report a net loss for tax purposes.
Having an understanding of what it will mean to you from a tax perspective is of utmost importance.
If you find yourself in the position where you are considering renting out your second home, having an understanding of what it will mean to you from a tax perspective is of utmost importance. These properties can be a great source for extra income, but you should also consider the costs associated with renting out the property. Will you have to hire someone to perform cleaning and maintenance services? If you plan to do those things yourself, is the value of your time worth the income you will realize? Also, what level of liability or risk are you comfortable taking on by letting someone else rent your home? Understanding the frequency and volume of renters that you will need to realize income, and to report a loss if necessary, is a key consideration. Talking through the potential return on investment, and your comfort level with allowing renters in your property with your financial advisor, attorney, and/or CPA can help you to make an informed decision on what is best for your specific property and situation.