As popular as vacation homes are, you might think the tax rules would be simply but they are fairly complex. Your tax strategies will depend on how you use the property; and you will need to carefully count and track days of personal use and rental use. Below are several must-know vacation home tax rules for the smart real estate investor.
If you rent a vacation home for 14 days or less in a year, the income can be tax-free but you cannot deduct any rental expenses. If you rent a vacation home for more than 14 days, you must divide your expenses between rental use and personal use.
If you use your vacation home during the year for "personal use" more than the greater of 14 days or 10% of the total days it is rented to others at a fair rental price, then it will be considered a "home". You must prorate your deductions based on how many days the property was rented at a fair rental price during the year. Also, your losses cannot offset more than the gross rental income from the property. You can, however, carry the losses forward as suspended losses to use in later years.
If you used the property for personal use but did not use it enough to be considered a home, you still must divide the expenses between personal use and rental use but you can potentially offset income from other sources with losses from the property in excess of gross rental income, subject to the at-risk rules and passive activity loss rules.
Personal use days do not include days substantially spent maintaining and repairing your vacation property- even if your kids are with you.
Deeded fractional interest time shares are subject to the same rules as other vacation properties but it is highly unlikely you could claim tax-free income based on the 14 days or less rental rule. This is because IRS counts the number of rental days for the entire property not just one owner.
It is possible to convert your vacation home into a primary residence and qualify for the $250,000/$500,000 primary residence exclusion. However, such a conversion can take up to five years and is subject to several other requirements. Consult your CPA or attorney for details.
Finding the right vacation property investment can be difficult, do your homework and clearly identify your personal and investment goals before you purchase. Once you have completed your preliminary research find a qualified Realtor who can provide the knowledge and services you need.