Vacation Homes & Your Taxes

Written by: Erik Bredberg

Do you own a vacation home? If so, you may be able to deduct a number of expenses on your tax return. The tax treatment depends on whether you use the property solely for personal use or rent it out.

Personal residence

If you use the home solely for personal use, you can deduct mortgage interest and property taxes as itemized deductions.

Remember that your mortgage interest deduction is capped at interest paid on the first $1 million of indebtedness, and that limit includes any mortgage you might have on your primary home.

Your property tax deduction might also be limited since the state and local tax (SALT) deduction is capped at $10,000. That limit includes state income or sales taxes, property taxes on your primary residence, and personal property taxes.

You can’t deduct any other expenses associated with the property, such as homeowner’s insurance, utilities, or association dues, as these are considered nondeductible personal expenses.

Remember, any significant home improvements can be added to the basis to offset gains on a future sale!

Personal use with limited rental use

There’s a special rule for vacation properties rented out fewer than 15 days per year. In this case, you can still deduct home mortgage interest and property taxes subject to the limitations outlined above, but you don’t have to report the rental income on your tax return.

Vacation home rented more than 14 days per year

Rental income is taxable if you rent your vacation property out more than 14 days per year. However, you can deduct more operating expenses.

You must allocate those expenses between personal use and rental days to calculate your deduction. For example, if you rent the property for 180 days and use it personally for 60 days, 75% of the use is rental (180 out of 240 days). You can deduct 75% of your utilities, insurance, mortgage interest, property taxes, repairs, and maintenance expenses against rental income.

Be aware that, whether claimed or not, the depreciation must also be calculated, lowering the basis in the property.

However, rental expenses are limited to your rental income. In other words, you can use your deductions to eliminate rental income, but you generally can’t claim a loss. You can carry forward any unused deductions to future tax years. If you are a real estate professional, please contact us for more information. You may be eligible to claim some losses on rental properties. A Walter Shuffain professional can better evaluate your unique situation.

In addition, 25% of the property’s mortgage interest and property taxes as deductible on Schedule A, subject to the $1 million/$10,000 caps mentioned previously.

Rental property

If your personal use of the property doesn’t exceed 14 days or 10% of the days you rent the home at fair market rates, then the vacation home isn’t considered a personal residence. IRS rules treat it as a rental property with limited personal use.

Rental income is taxable, and your rental expenses aren’t limited to rental income. You still must allocate your rental deductions based on the days the property was rented out or available to rent, and you can’t deduct the personal use portion of your mortgage interest or real estate taxes.

If your rental expenses exceed rental income, the loss might be subject to passive loss rules. The IRS considers real estate to be a passive investment. Passive losses can typically only offset passive income, such as income from another rental property or from a business in which you don’t participate in the day-to-day operations.

Any disallowed passive losses from the rental property can be carried forward to future tax years and deducted when you have sufficient passive income or sell the property.

There are a couple of exceptions to the passive activity loss rules. For example, you can deduct up to $25,000 of passive real estate losses if you actively participate in the property and have adjusted gross income (AGI) under $100,000.

Another exception applies to real estate professionals. If you pass the following two tests, you can deduct any real estate losses even if you have little or no passive income.

    • You spend more than 750 hours during the year delivering personal services in real estate activities in which you materially participate, and
    • Those hours are more than half the time you work during the year.

As you can see, the rules for deducting vacation home expenses are complex. Claiming vacation home rental income and deductions can change from year to year depending on how many days you use the property personally versus how many days you rent it out.

For that reason, keeping good records documenting how you use the property is essential. If you have any questions about how the vacation home rules apply to your situation or would like to maximize deductions, reach out to your Walter Shuffain advisor.