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Do you have a home you use for personal reasons and rent out? If so, it’s a vacation home as defined by the tax code, which means it must be labeled as either a personal residence or rental property.

But how do you know if it’s rental property?

Ask yourself the following questions:

  • Do I rent it out for over 14 days in the calendar year?
  • Do I use the property for personal uses for fewer than 14 days or 10% of the days I rent it out?

If you use the property as a rental, you must determine the number of days it’s a rental as you’ll allocate expenses, such as mortgage interest, property taxes, and other typical housing expenses, based on the number of days it was rented, versus used for personal purposes.

Here’s the catch.

You can’t take the qualified residence interest deduction if you use the property as a rental property, even part-time. This is only applicable on properties used for personal purposes.

But there’s good news.

If the rental expenses incurred exceed the rental income (on paper), you can take a deductible tax loss on Schedule E.

But there’s another catch.

You may lose it to PAL rules. These rules state you can only deduct passive losses up to the point that you have passive income from other sources. In other words, you’d need a rental property with positive income to offset the loss.

If you can’t use your passive loss, though, you can carry it forward to a year that you have enough passive income to allow the deduction or if you ‘actively participate’ in your rental and have an AGI of $100,000 or less, the PAL rules have a $25,000 exception unless the average rental period for your property is less than 7 days or the average period is less than 30 days, and the owner provides significant personal services.

One final exception occurs if you:

  • Spend at least 750 hours annually actively participating in the real estate
  • The hours you put into the real estate is more than 50% of the time you spend offering personal services

I know this can all get confusing. Feel free to reach out with questions or concerns about rental property you own to see how to maximize your tax deductions.