The best type of income is tax-free income. Ordinarily, any rental income you receive is taxable. However, there is one little known exception that can be particularly useful this time of year.
You can rent out your vacation home for up to 14 days per year and all the rental income you receive is tax free, no matter how much you earn. In fact you don't even have to report the income to the IRS.
This rule can provide you with a real windfall if you own a vacation home in a desirable area where people are looking for short-term rentals.
However, your vacation home rental income is tax free only if, during the year:
- you rent out your vacation home for less than 15 days, and
- the home is used personally for 15 days or more. (IRC Sec. 280A(g).)
Example: Claudia rents her Florida beachfront condominium for 14 days during the summer. She lives in the condo herself for two months during the year. Her condo qualifies as a tax-free vacation home.
Calculating Personal and Rental Use
Determining whether vacation rental income is tax free depends on how many days during the year the home is used for personal use by the owner and how many days it’s rented. As you might expect, there are tax rules for determining this.
A day of personal use of a vacation home is any day that it is used by:
- you or any co-owner of the property
- a member of your family or a member of the family of any co-owner (unless the family member uses the home as his or her main home and pays a fair rental price)
- anyone under an arrangement that lets you use some other home,
- anyone at less than a fair rental price.
Any day you rent your vacation home at a fair market rent is a day of rental use no matter who you rent it to, unless it’s a family member who doesn’t live there full-time. Any day you rent your vacation home to anyone for less than a fair rental price is considered a day of personal use.
A fair rental price for your property is the amount of rent that a person who is not related to you would be willing to pay. The rent you charge is not a fair rental price if it is substantially less than the rents charged for other properties that are similar to your property.
Example: Dick owns a vacation home that he used himself for 14 days and rented as follows:
- two days to his brother, who paid a fair rental price, but doesn’t live in the home full-time
- four days to his mother, who paid nothing
- 14 days to a stranger who paid a fair market rental, and
- two days to a friend from the office who paid a below fair market price.
Dick’s own use is personal use. The two days he rented it his brother are also personal days because his brother doesn’t live there full-time. The four days his mother used the house are also personal days. The 14 days he rented it to strangers for a fair market price are rental days. The two days he let a friend use it for a below market rental are personal days. His totals for the year are:
Rental days = 14
Personal days = 22
The vacation home qualifies as a tax-free vacation home because it was used personally more than 14 days and rented less than 15 days. This means Dick need not pay any income tax on the rental income he received. Had Dick rented it to the strangers for one more day, the house would have come within the vacation home used as residence category with very different tax results.
Tax Deductions for Your Vacation Home
The tax deduction rules applicable to any personal vacation home or second home apply to vacation homes in this category. Under these rules, all your real estate taxes are deducted as a personal itemized deduction on your IRS Schedule A. Because the home is treated as a personal residence for tax purposes, you may not deduct any operating expenses for the property or take any depreciation deduction. You don’t file Schedule E, the tax form landlords file to report their income and expenses, because your home is not a rental property.