Once you've purchased the home, the last thing you want to think about is taxes. Especially if you're earning a little money from the property.
We can't blame you. It's nice to have a little extra income from a property you already love.
But vacation homes come with certain tax rules that are different from a primary residence. Here, we're breaking down the essential vacation rental tax rules that you need to know to prepare your paperwork for Tax Day.
Because while an easy Tax Day isn't quite as nice as a day at the beach, it makes that day at the beach way more relaxing.
Is Your Vacation Home a Vacation Home?
First things first: is your vacation home actually a vacation home?
If you don't understand why we need to ask that question, we're going to cover a few basics.
What we're really asking here is whether your vacation home is a rental property (i.e. investment property) or a second home. In the eyes of the IRS, these are two very different things.
Rental Property vs. Second Home
A vacation home can be viewed as either a rental property or a second home, but how it's classified to the IRS will change how you file taxes for that property.
If your vacation home is an investment property, then these two things must be true:
- It is not your primary residence
- It was purchased for the purpose of generating income
Basically, if you buy a property with the intention of making money off of it rather than having your family live there, then that property is an investment property.
A second home is an entirely different beast. It's defined as a residence which you and your family occupy for part of the year in addition to your primary residence. Usually, it's used as a vacation home, though it could be a condo or apartment in a city where you regularly conduct business.
Tax Treatment of Rental and Investment Properties
If your property qualifies as a rental or investment property, it's taxed entirely differently from a primary residence or a second home.
Because these properties are purchased and owned with the express intent of making an income, you need to report your rental income and expenses on the Schedule E form. You will then pay the taxes you owe after deducting your expenses.
If you lost money on the property, you have two options:
- Use the losses to offset income from other properties, or
- Claim up to $25,000 of the loss against other income
Keep in mind, however, that you must have an adjusted gross income of $100,000 or less in order to fully claim the loss.
Tax Treatment of Second Homes
Second homes, on the other hand, get treated the same as a primary residence when Tax Day rolls around.
This means that all the same rules apply to your mortgage, property taxes, and interest.
For example, you can write off up to $1 million in mortgage debt incurred in buying or improving the property. You can also write off up to $100,000 in home equity debt, which is a debt against your first or second property that was not incurred for the purposes of buying or improving the properties.
These limits are overall, not on a per-property basis, so if your net mortgage debt is greater than $1 million between the two properties, you can only write off the first $1 million of mortgage debt.
Does Your Home Qualify as a Residence?
This begs the question: how do you know if your home qualifies as a residence?
What if you use it as a second residence but rent it out through services like Airbnb part of the time?
Basically, if your home is rented for at least 15 days of the year and your days of personal use qualify your home as a residence, then the rules of a vacation home apply. If you have absolutely no idea what that meant, read the next section.
* Please note, we are not accountants, attornies or homes inspection companies, we are real estate brokers. You want to check with professionals for their financial help.
A Few Vacation Rental Tax Rules
While there are several tax rules that law-abiding, taxpaying investment property owners should abide by, there are two big ones that come up the most often:
- The 14-day rule
- The personal use rule
These two rules are the easiest guidelines to follow to figure out what your property is considered in the eyes of the IRS and how you'll be expected to pay taxes on it.
The 14-Day Rule
Think of the 14-day rule as the golden rule of rental properties, because that's exactly what it is.
In the simplest possible terms, if you rent out your property for less than 14 days of the calendar year, then you can pocket the income without the property being viewed as a rental property, which means you don't have to pay taxes on it.
If you rent out your property for more than 14 days of the year, then the property is officially an investment property in the eyes of the IRS and, tragically, you have to pay taxes on the income.
If the home is considered a rental property, then the property falls into one of three categories:
- Rented for 14 days or less
- Rented for 15 days or more and used by the homeowner for less than 14 days
- The owner uses the property for more than the 14 days the home was rented
If the property is rented for less than 14 days, then it is still considered a personal residence and rental income is not taxable. This is good news because you can still deduct mortgage interest and property taxes under Schedule A.
If you fall into the second category, then the property is a rental and all rental income is viewed as business income. As such, all rental income must be reported to the IRS and the owner can deduct rental expenses like:
- Mortgage interest
- Property taxes
- Insurance premiums
- Maintenance expenses
The amount of rental expenses that can be deducted is based on the percentage of days that the home was rented out, which is calculated by dividing the total number of days the home was rented by the total number of days the home was used (rental days plus personal days).
Finally, if you fall into the third category (the home was used as a personal residence for more than 14 days of the year) then the property is again viewed as a personal residence and rental losses cannot be deducted.
As you can see, the 14-day rule has a dramatic effect on how your property is taxed, so it's vital that you keep good records.
Part of the 14-day equation is personal use. What does that actually mean?
Well, the actual definition of personal use is fairly broad.
It includes any days that you, your family, or a relative stayed in the property (even if that relative was paying rent), but it also includes days that you have donated use of the house (for use in a charity event, for example) or days that you rented it out for less than fair market value.
Again, good record-keeping is vital.
Vacation Rental Property Tax Deductions
So, if you've got a grasp on the whole 14-day rule and personal use rule, then we should take some time to talk about potential tax deductions for your property.
Writing Off Rental Expenses
As it turns out, many rental expenses can be written off under Schedule E, which is great news if you own a rental property.
Some common things you can write off include:
- Homeowner's association dues
- Condo dues
- Insurance premiums
- Cleaning and maintenance
- Legal fees
- Mortgage interest
- Commissions paid to rental agents
However, it also includes less obvious deductions, like fees required to pay an accountant for your Schedule E taxes.
You can also deduct travel expenses, but with certain limits. If you travel locally to your rental property, you can write off costs like maintenance or showing it. You can also write off the standard mileage rate plus parking and tolls (if you use your own car).
If you travel outside your local area, then the story is a bit different. You can write off expenses if you're traveling to collect rent or if you're traveling to maintain, conserve, or manage the property.
Repairs vs. Improvements
There's a lot of tricky IRS rules around the question of repairs vs. improvements.
It sounds like an issue of semantics, but it's a big difference in the eyes of the IRS. You can deduct the cost of a repair in a single year, but if a cost is classified as an improvement, you have to depreciate the cost for as many as 27.5 years.
An improvement, according to the IRS, is when a property undergoes a betterment, adaptation, or restoration. If you're not sure whether something qualifies as an improvement, consider whether it was needed as a result of a particular event (like a storm) or whether you're correcting wear and tear.
Tips to Make Tax Day Easier
Even after you have a grasp on how your property is classified and you understand the types of deductions available to you, Tax Day with a vacation house can still feel incredibly confusing.
The good news is that there are a couple things you can do to make your life a little easier before Tax Day rolls around.
Keep Flawless Records
Perhaps the single best thing you can do for yourself is to keep flawless records.
As we've noted, the 14-day rule and the number of days you use the residence for personal purposes are a huge defining factor in the tax classification of your property.
But both only give you a span of about two weeks before your property stops being a residence and starts being an investment property. If those 14 days are spread out as a few days here and there over several months, it can be tricky to keep track of whether you've passed the 14-day mark or not.
And that can land you in trouble when Tax Day rolls around.
You'll have a much easier time managing your property if you treat it like a business from the very beginning. Keep pristine records of everything, but especially rental periods.
Fill Out Form W-9 Taxpayer Identification Number
Filling out your W-9 form isn't just for your taxes in the future, though that plays a big role.
Companies like Airbnb, Flipkey, and HomeAway all have to withhold a full 28 percent of your rental income if you don't provide them with your W-9. And there's no good reason to lose 28 percent of your rental income all year when filling out the form shouldn't take you more than 10 or 15 minutes.
Do yourself a favor. Fill out the form and save a copy.
Deduct Guest-Service and Host-Service Fees
Most short-term rental companies like Airbnb charge a percentage fee, which is usually called either a guest-service fee or a host-service fee.
This is taken off the top of what guests pay, so you never see it. It does, however, appear on the 1099 form that Airbnb and other companies send to the IRS each year to report your rental earnings.
You can (and should) deduct these fees from your rental income (if you rented for less than 14 days of the year).
Finding Your Rental Property in Myrtle Beach
You know the vacation rental tax rules, you know how to classify your property, you know what you need to fill out, and you know how to make your life easier next April.
What are you waiting for?
Click here to check out some of our featured properties in Myrtle Beach -- you never know, your vacation home might just be waiting for you!