Tax Rules for Renting out Your Vacation Home

Did you know that you can rent out your home for up to two weeks a year without reporting the rental income? This tax break is informally known as the Augusta rule for some of its biggest beneficiaries: people who own homes near the Augusta National Golf Club and earn up to $20,000 in tax-free income by renting the homes for the duration of the annual tournament.

You don’t have to live in Augusta to take advantage of the Augusta rule. You can even deduct any mortgage interest and property taxes as usual. You can’t, however, deduct any rental expenses you incur by taking advantage of the Augusta rule.

There are a few other Internal Revenue Service (IRS) rules to be aware of before you take full advantage of the Augusta rule.

Key Takeaways

• Homeowners who rent out their properties for up to 14 days without owing taxes on that income.
• Expenses related to the rental are not deductible.
• Other rules on taxes and deductions for renting your home will apply, depending on how many days it is rented and how many days you live in it.

Understanding the Rules for Renting a Vacation Home

Generally, if a homeowner is paid rental income, the income is taxable. The homeowner can usually deduct certain expenses to reduce the taxable amount due.

Homeowners who rent their residences part of the year are subject to different rules depending on the number of days they live in the home and the number of days they rent it out.

The 14-Day or 10% Rule

The famous Augusta rule is one of three general categories of home rental income that have their own IRS rules.

In general, the tax benefits depend upon the number of days in a year that the property is rented out, and how much time the owner spends in the home. If a primary home or a vacation home is used exclusively for the owner’s personal enjoyment and is not rented out at any time during the year, the owner can usually deduct real estate taxes and interest on a home mortgage.

As with a primary residence, the costs associated with insurance, maintenance, and utilities cannot be deducted.

If the home is used for rental purposes, the use of the property will fall into one of three categories.

Property Rented for 14 days or Less Each Year

This is the famous Augusta rule.

A vacation property can be rented out for up to two weeks (14 nights) each year without the need to report the rental income.

In this case, the house is still considered a personal residence, so the owner can deduct mortgage interest and property taxes on a Schedule A under the standard second home rules.

However, the owner cannot deduct any expenses as rental expenses.

This tax break is informally known as the Augusta rule or the Masters exemption because vacation homeowners in Augusta, Georgia, supposedly lobbied for the exemption back in the 1970s to benefit from the proximity of their homes to the world-famous annual golf tournament.

Rented for More than 15 Days and Used for Less than 14 Days

Vacation homes that are used primarily as rental properties are required to pay taxes on the rental income but they can deduct certain related expenses.

In this case, the property is considered a rental property, and the rental activities are viewed as a business. All rental income must be reported to the IRS, and the owner can deduct certain rental expenses, including the following:

• Fees paid to property managers
• Insurance premiums
• Maintenance expenses
• Mortgage Interest
• Property taxes
• Utilities
• Depreciation

The amount of rental expenses that can be deducted is based on the percentage of days that the home was rented out, called “rental days.” The deductible expenses are calculated by dividing the number of days the home was rented out by the total number of days the home was used: rental days plus personal use days.

For example, if a vacation home had 120 total days of use, and 100 of those days were rental days, 83% of the expenses (100 rental days/120 total days of use) can be deducted against the rental income. The rental portion of the expenses in excess of the rental income cannot be deducted. The owner would not be able to deduct the remaining 17% of the rental expenses.

In addition to deducting rental expenses, owners may be able to deduct up to $25,000 each year in losses, depending on the adjusted gross income (AGI) of the owner, and passive losses can be written off if they manage the property themselves. A passive loss is a loss that can be deducted if the taxpayer does not materially participate in the rental property.

The Owner Uses the Property for More than 14 Days or 10% of the Total Days the Home Was Rented

This rule applies to second homeowners who rent their second homes frequently but reserve substantial amounts of time for their personal use. It’s important to note that exceeding the 14-day cap on the rental of the property can have a dramatic effect on your taxes.

If personal days exceed 14 days or 10% of the number of days the home is rented—whichever is greater—the IRS considers the property a personal residence and rental loss cannot be deducted. Rental expenses, up to the level of rental income, as well as property taxes and mortgage interest, can still be deducted.

Since the 14-day cutoff can have a serious effect on your taxes, it’s wise to track and document personal use days versus days used for repairs and maintenance. According to the IRS, personal use days can include:

Any day that you spend working substantially full time repairing and maintaining (not improving) your property isn’t counted as a day of personal use. Don’t count such a day as a day of personal use even if family members use the property for recreational purposes on the same day.

How Is Rental Income Taxed?

In general, rental income is taxed as ordinary income, and the expenses related to renting it are deductible.

There are exceptions, however, that can benefit people who rent their primary residences or vacation residences for short periods of the year while reserving them for their personal use most of the time.

The big break is the so-called Augusta rule, which allows homeowners to rent out their properties for up to 14 days a year without paying taxes on that income.

There are other rules for short-term rentals of personal residences. The rules differ depending on the number of days the property is rented out and the number of days the owner is in residence.

What Deductions Are Available on Rental Income?

Owners of properties that are rented full-time are eligible for a number of tax deductions including mortgage interest, property taxes, depreciation, and related expenses.

The rules can be different if you rent out your residence or a second home for short periods each year. If you rent the property out for 14 days or less, you don’t owe tax on the income but you don’t get any related deductions.

Can a Business Use the Augusta Rule?

Under certain circumstances, a business owner who owns a vacation home can rent the home to his or her own LLC for up to two weeks a year. Neither the individual nor the LLC will owe taxes on the rental income. The rules are strict, and are to be used only if the property is used for business purposes such as a meeting or a retreat.

The Bottom Line

Owners who rent out their homes for part of the year may be able to take advantage of certain tax benefits, making a primary residence or a second home more affordable. The tax laws provide very different benefits, depending on the number of days that the property is rented out each year and the amount of time the owner uses the home.

Since tax laws can be complex and change frequently, it may be helpful to consult with a qualified tax specialist to determine the best approach to renting out your vacation home.

Read the original article on Investopedia.