Tax Rules for Rental Properties and Vacation Homes

Tax Summer Series #3

Summer is a popular time to travel, which means increased demand for rental properties as many travelers prefer the comforts of home that they provide over hotels. With companies like Airbnb and VRBO making renting real estate easier and more accessible, chances are you’ve noticed more of your clients reporting rental activity in recent years.

In this post, we’ll review the income tax basics of reporting rental activity, including income and deductible expenses, vacation home and passive activity rules, as well as record-keeping best practices you can share with your clients.

Rental Income and Expenses

Rental Income

Rental income is cash or the fair market value of any property or services a taxpayer receives in exchange for the use or occupation of their real estate. For taxpayers operating on a cash basis, they report rental income in the year when it is constructively received.

In addition to payments received for the temporary use of their property, remind your clients that the following types of payments are also considered rental income:

• Lease cancellation payments
• Advanced rent
• Expenses paid by the tenant
• Unreturned security deposits
• Services performed by the tenant in lieu of rent

Rental Expenses

To offset their rental income, taxpayers can deduct ordinary and necessary expenses incurred to manage and operate their rental property. Taxpayers deduct expenses in the year they are paid.

Examples of deductible expenses include:

• Mortgage interest
• Property tax
• Utilities
• Management fees
• Repairs and Maintenance
• Insurance
• Travel (ensure expenses meet the requirements of Publication 463, Travel, Entertainment, Gift, and Car Expenses).

In some cases, it is necessary to depreciate rental property costs instead of expensing them. Depreciable costs include:

• The cost of the real estate owned, excluding land
• Furniture and appliances
• Improvements or costs that increase the value of the property or extend its life

SALT Deduction Limitation

It’s important to remind clients that the State and Local Tax (SALT) deduction is currently capped at $10,000 ($5,000 for married filing separately) under the Tax Cuts and Jobs Act (TCJA), which remains in effect through the end of 2025 unless extended or modified by Congress. This cap applies to the total of all state and local income, sales, and property taxes claimed as itemized deductions. While property taxes on rental properties are generally deductible as a business expense and not subject to the SALT cap, property taxes on personal-use portions of a mixed-use property (such as a vacation home) are subject to this limitation when claimed on Schedule A. Clients should be aware of this distinction when allocating expenses between personal and rental use.

Personal Use vs Rental Expenses

Taxpayers who use their real estate for both personal and business purposes must split expenses between personal use and rental activity. Expenses are divided based on the number of days used for personal reasons as compared to rental days. Taxpayers may report the personal portion of some expenses like mortgage interest and property taxes on Schedule A, Itemized Deductions, but other personal expenses are not deductible.

A personal use day is any day:

• The taxpayer or another person who has an interest in the property uses the property
• A family member uses the property unless they use it as their main home and pay a fair rental price
• A renter pays less than a fair rental price
• Anyone who the taxpayer has an agreement with to use another dwelling unit uses the property

Special Rules and Exceptions

Minimal Rental Use

When special events, such as concerts or golf tournaments, take place nearby, a client may take advantage of the increased demand and rent out their home for a short period. If a property is used as the client’s home and rented out for fewer than 15 days during the year, the taxpayer does not need to report the rental income, and any expenses are not deducted (excluding personal ones like mortgage interest reported elsewhere).

Passive Activity Loss Rules

Rental property income is considered a passive activity unless the taxpayer materially participates and is a real estate professional. Generally, taxpayers cannot deduct passive activity losses. Instead, taxpayers carry forward the losses to offset future passive income (not including investments) or when the taxpayer completely disposes of their interest in the property. Use Form 8582, Passive Activity Loss Limitations, to track passive activity losses.

A special rule allows taxpayers to deduct up to $25,000 in passive losses from a rental activity against nonpassive income if the taxpayer actively participates in the rental activity. The deduction is subject to phase-out income limits, so only taxpayers with a modified adjusted gross income (MAGI) under $100,000 ($50,000 for MFS) can deduct the entire $25,000, and the deduction is completely phased out for taxpayers with an AGI over $150,000 ($75,000 MFS).

At-Risk Rules

The at-risk rules limit the amount a taxpayer can deduct from rental activity losses to the amount they invested in the property or any borrowed amounts for use in the activity if they are liable for repayment. Borrowed amounts from another person with an interest in the activity or a related person are excluded from a taxpayer’s at-risk amount. If a taxpayer has rental activity losses that exceed their at-risk basis, the losses are not deductible until the taxpayer increases their at-risk basis. At-Risk losses are reported on Form 6198, At-Risk Limitations.

Practical Tips for Homeowners

Keeping Accurate Records

It’s essential for clients operating a rental property to maintain clean and accurate records to ensure they capture all related income and expenses. Clients who keep updated records will not only help you prepare their financial statements and tax returns but are also necessary to substantiate amounts with the taxing authorities. You should ensure your clients understand that if they are unable to substantiate expenses, they may be subject to additional taxes and penalties in the case of an audit.

Consider creating and offering clients a spreadsheet template to track their rental property income and expenses contemporaneously. Encourage taxpayers not to wait until the end of the year or during tax season to gather their rental property information, as potential expenses may be missed or forgotten. Inform them to maintain receipts, canceled checks, and any other documentation to support expenses. Even though they do not need to provide documentation to you to prepare the tax return, you can offer clients to store their receipts in your firm’s document portal, so they have a secure and centralized place to house them.

Conclusion

As rental properties and vacation homes gain in popularity, understanding the rules and reporting requirements will help you better serve your clients while maximizing their tax benefits.

By Ashley Akin, CPA

Sources:

• Topic no. 414, Rental income and expenses | Internal Revenue Service
• Topic no. 415, Renting residential and vacation property | Internal Revenue Service
• Publication 925 (2024), Passive Activity and At-Risk Rules | Internal Revenue Service
• Publication 946 (2024), How To Depreciate Property | Internal Revenue Service
• SALT Deduction: Three Things to Know For 2025