Know-the-Vacation-Home-Tax-Rules-Before-Renting

Summer is just around the corner. If you’re fortunate enough to own a vacation property, you may wonder about the tax consequences of renting it out for part of the year. We’ll break down the specifics so that you know the vacation home tax rules before renting this summer.

Duration is a Factor

The tax treatment depends on how many days the home is rented and your level of personal use. Personal use includes vacation use by your relatives (even if you charge them market rate rent) and use by nonrelatives if a market rate rent isn’t charged.

If you rent the property out for less than 15 days during the year, it’s not treated as “rental property” at all. In the right circumstances, this can produce significant tax benefits. Any rent you receive isn’t included in your income for tax purposes (no matter how substantial). On the other hand, you can only deduct property taxes and mortgage interest — no other operating costs and no depreciation. (Mortgage interest is deductible on your principal residence and one other home, subject to certain limits.)

If you rent the property out for more than 14 days, you must include the rent you receive in income. However, you can deduct part of your operating expenses and depreciation, subject to several rules.

First, you must allocate your expenses between the personal use days and the rental days. For example, if the house is rented for 90 days and used personally for 30 days, then 75% of the use is rental (90 days out of 120 total days). You would allocate 75% of your maintenance, utilities, insurance, etc., costs to rental. You would allocate 75% of your depreciation allowance, interest, and taxes for the property to rental as well. The personal use portion of taxes is separately deductible. The personal use portion of interest on a second home is also deductible if the personal use exceeds the greater of 14 days or 10% of the rental days. However, depreciation on the personal use portion isn’t allowed.

If the rental income exceeds these allocable deductions, you report the rent and deductions to determine the amount of rental income to add to your other income. If the expenses exceed the income, you may be able to claim a rental loss. This depends on how many days you use the house personally.

Put it to the Test

Here’s the test: if you use the property personally for more than the greater of 1) 14 days, or 2) 10% of the rental days, you’re using it “too much,” and you can’t claim your loss. In this case, you can still use your deductions to wipe out rental income, but you can’t go beyond that to create a loss. Any unused deductions are carried forward and may be usable in future years. If you’re limited to using deductions only up to the amount of rental income, you must use the deductions allocated to the rental portion in the following order: 1) interest and taxes, 2) operating costs, 3) depreciation.

If you “pass” the personal use test (i.e., you don’t use the property personally more than the greater of the figures listed above), you must still allocate your expenses between the personal and rental portions. In this case, however, if your rental deductions exceed rental income, you can claim the loss. (The loss is “passive,” however, and may be limited under the passive loss rules.)

Rely on the Experts

As you can see, the rules are complex. But knowing the vacation home tax rules before renting can help you plan ahead and maximize deductions. The professional team at Ramsay & Associates can help you better understand these regulations to benefit your specific situation. Contact us with questions.

Many people who launch small businesses start out as sole proprietors. But what are the tax aspects of your new business? Here are nine tax rules and considerations involved in operating as that entity.

1. You may qualify for the pass-through deduction.

To the extent your business generates qualified business income, you are eligible to claim the 20 percent pass-through deduction, subject to limitations. The deduction is taken “below the line,” meaning it reduces taxable income, rather than being taken “above the line” against your gross income. However, you can take the deduction even if you don’t itemize deductions and instead claim the standard deduction.

2. Report income and expenses on Schedule C of Form 1040.

The net income will be taxable to you regardless of whether you withdraw cash from the business. Your business expenses are deductible against gross income and not as itemized deductions. If you have losses, they will generally be deductible against your other income, subject to special rules related to hobby losses, passive activity losses, and losses in activities in which you weren’t “at risk.”

3. Pay self-employment taxes.

For 2020, you pay self-employment tax (Social Security and Medicare) at a 15.3 percent rate on your net earnings from self-employment of up to $137,700, and Medicare tax only at a 2.9 percent rate on the excess. An additional 0.9 percent Medicare tax (for a total of 3.8 percent) is imposed on self-employment income in excess of $250,000 for joint returns; $125,000 for married taxpayers filing separate returns; and $200,000 in all other cases. Self-employment tax is imposed in addition to income tax, but you can deduct half of your self-employment tax as an adjustment to income.

4. Make quarterly estimated tax payments.

For 2020, these are due April 15, June 15, September 15, and January 15, 2021.

5. You may be able to deduct home office expenses.

If you work from a home office, perform management or administrative tasks there, or store product samples or inventory at home, you may be entitled to deduct an allocable portion of some costs of maintaining your home. And if you have a home office, you may be able to deduct expenses of traveling from there to another work location.

6. You can deduct 100 percent of your health insurance costs as a business expense.

This means your deduction for medical care insurance won’t be subject to the rule that limits medical expense deductions.

7. Keep complete records of your income and expenses.

Specifically, you should carefully record your expenses in order to claim all the tax breaks to which you’re entitled. Certain expenses, such as automobile, travel, meals, and office-at-home expenses, require special attention because they’re subject to special recordkeeping rules or deductibility limits.

8. If you hire employees, you need to get a taxpayer identification number and withhold and pay employment taxes.

9. Consider establishing a qualified retirement plan.

The advantage is that amounts contributed to the plan are deductible at the time of the contribution and aren’t taken into income until they’re are withdrawn. Because many qualified plans can be complex, you might consider a SEP plan, which requires less paperwork. A SIMPLE plan is also available to sole proprietors that offers tax advantages with fewer restrictions and administrative requirements. If you don’t establish a retirement plan, you may still be able to contribute to an IRA.

Seek assistance

If you want additional information regarding the tax aspects of your new business, or if you have questions about reporting or recordkeeping requirements, please contact us.

651.429.9111

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Rich Ramsay at Rich@RamsayWealth.com