Tax Rules for Rentals and Vacation Homes

The rise of booking platforms, like Airbnb and VRBO, makes it simple for taxpayers to rent vacation homes during down times. However, the IRS has clear guidelines for determining personal use days and when rental income reporting is required.

In this article, we’ll cover the basics of vacation home rentals, including the details of the 14-day rule, an overview of Augusta Rules, how mixed-use rentals are reported, and key tax reporting differences for short-term rentals.

The Qualifications for Personal Use

IRS Topic 415 outlines the criteria for determining personal use days. If any of the following conditions are met, the day is considered personal use:

• The taxpayer occupies the vacation home.
• A member of the taxpayer’s family occupies the vacation home, such as a spouse or child.
• The taxpayer has an agreement to occupy another dwelling unit, such as swapping homes.
• The taxpayer rents the vacation property at less than the fair rental price.

The 14-Day Rule  

The reporting of rental income and expenses associated with vacation homes depends on the volume of personal use. Under IRS Topic 415, taxpayers who use the dwelling unit for greater than 14 days or 10% of the total days rented at a fair rental price must report the rental income. They must allocate expenses proportionately between rental and personal use days based on the number of days..

Let’s say a taxpayer uses a vacation home for three months out of the year. During the other nine months, the property is rented to unrelated individuals. The taxpayer can deduct expenses associated with the nine rental months as rental expenses but not expenses associated with the three months of personal use. However, they may be able to deduct the expenses associated with the three months of personal use as itemized deductions.

Taxpayers who are under the personal use thresholds can deduct rental expenses in proportion to the time the property was rented to unrelated persons. For example, suppose the taxpayer uses the vacation home for one week and rents it out for the remainder of the year. In that case, they can deduct the expenses associated with all but the seven days they used the property as rental expenses. If the taxpayer has a $10,000 property tax bill on the property, they can claim a $9,808 rental deduction ($10,000 × (365 days – 7 days)/365 days).

Flipping this scenario, if the taxpayer were to rent the vacation property only one week out of the year, they would not be required to report any rental income. This also means that no expenses are deductible as rental expenses, even though they may be deductible as itemized deductions in some cases.

The Augusta Rule

Under IRC §280A, taxpayers can also receive an exemption from rental reporting requirements if the vacation home is rented to a business for less than 14 days. This regulation, also known as the Augusta Rule, follows the same requirements as the 14-day rule under IRS Topic 415.

Let’s say that the taxpayer holds an annual business conference in Florida and has a vacation home that would fulfill the needs for the conference. Under Section 280A, the taxpayer can collect rent at the fair market value for up to 14 days from the business. The business will be able to deduct the payment as a qualifying expense, while the taxpayer is not required to report the rental payment as income.

If the business were to rent the vacation home in Florida for over 14 days, the taxpayer would be required to report the rental income. This would result in the deductibility of expenses related to the time the unit is occupied, like utilities and taxes.

Mixed-Use Rentals

A mixed-use rental occurs when the taxpayer occupies the vacation home for more than 14 days and collects rental income. Mixed-use rentals require the taxpayer to report rental income with offsetting expenses. As a best practice, taxpayers should track expenses related to the rented days. However, the IRS does allow taxpayers to deduct proportional expenses related to the rental.

For example, the taxpayer rented out the vacation home for 200 out of the 365 days during the year. They incurred $10,000 in taxes, $8,000 in utilities, and $5,000 in insurance. Dividing 200 by 365 days results in 54.8% of expenses being deductible. The taxpayer can deduct $5,480 in taxes, $4,384 in utilities, and $2,740 in insurance as rental expenses.

Depending on the taxpayer’s involvement in the rental, passive activity losses might apply when rental expenses exceed income. There is a special $25,000 special allowance for rental real estate activities that taxpayers with active participation can claim on Form 8582. For the 2023 tax year, the allowance for individuals using the single or married filing jointly filing status begins to phase out at $100,000 modified AGI, with a full phaseout once $150,000 is reached.

Short-Term Rentals

Short-term rentals primarily relate to stays of less than seven days on average. Short-term rentals aren’t reported on Schedule E. In fact, IRS Publication 527 states that taxpayers should use Schedule C to report rental transactions if the taxpayer provides “substantial services in conjunction with the property or the rental is a part of a trade or business as a real estate dealer.”

Substantial services are tasks that are related to the convenience of the tenant, like cleaning and linen changes. If the taxpayer meets these requirements, there is the potential for more deductions associated with the rental; however, net profits are generally subject to self-employment taxes.

Summary

Vacation home rentals can be a way for taxpayers to defray some of the costs of owning a vacation or second home. However, as tax practitioners, you need to be aware of the reporting requirements and legislation surrounding rentals to maximize tax savings.

By Rachel Szeklinski, CPA

Sources

• IRS Topic 415 (07/2024), Renting Residential and Vacation Property | Internal Revenue Service (irs.gov)
• 26 U.S. Code § 280A
• IRS Form 8582 (2023), Passive Activity Loss Limitations | Internal Revenue Service (irs.gov)
• IRS Publication 925 (03/2024), Passive Activity and At-Risk Rules | Internal Revenue Service (irs.gov)
• IRS Publication 527 (2023), Residential Rental Property | Internal Revenue Service (irs.gov)