Over the years many online short-term home rental sites have increased in popularity, such as Home Away and Airbnb, allowing a homeowner convenience in renting a personal home for a couple of weekends each year. Also, in many circles of society, it is very popular to donate use of a rental property to charities to auction at fundraisers. Both situations could cause very different tax implications that should be reviewed prior to entering into either situation. The rules of the Internal Revenue Service (IRS) depend heavily on the personal-use days of the property, and development of a plan of use early in the tax year may be helpful to achieve the desired tax results.
Personal-use days: The primary determination in how the rental income is treated is based on personal-use days. What is considered a personal-use day? The definition is fairly broad; however, any time the property is used by the taxpayer or family members (if rent is being paid at a below-market rate) it is considered personal use. Personal use days also include days the property is donated as part of a charity auction. Days spent by a taxpayer working substantially full-time on repairs, painting, maintaining or cleaning the property are not considered personal-use days, even if family members use the property for recreation on the same days.
Personal-use property: If the property is used primarily for personal use, the taxpayer does not report any rental income. This can be beneficial in the case of many short-term rental web sites or if a personal residence is rented when there is a special event in town. With any exclusion of income there are restrictions imposed by the IRS. The property cannot be rented for more than 14 days during the calendar year, and any direct rental or other rental expenses are not deductible. Real estate taxes or mortgage interest on the property could be deducted as an itemized deduction subject to certain restrictions.
Personal-use rental property: Once the property is rented for more than 14 days, the taxpayer is required to report the income. When the personal-use days are more than 14 days, or 10 percent of the fair market rental days, the tax implication are much more complicated. The expenses allocable to the time the property was rented are deductible to the extent of rental income but no losses can be deducted. Certain property costs, such as mortgage interest and real estate taxes, could be partially deducted as an itemized deduction subject to certain restrictions.
Rental property: The final scenario is when the property is rented more than 14 days at market rate and the personal-use days are fewer than 14 days or 10 percent of the fair market rental days. In this situation, the rental expenses are allocated based on use. Any real estate taxes allocated to personal use could be included as itemized deductions, and all other expenses related to the time the property was rented can be deducted against income and create a rental loss. This loss can then be available to offset other income subject to phase-outs and restrictions. The downfall is that the mortgage interest related to personal use is not deductible as an itemized deduction.
Rental property is generally a great way to build wealth and increase cash flow, and in some instances, a good way to give back to your community with charitable-use donations. However, as noted above, there are many complex tax regulations that accompany the rental of any property. Consult a CPA to help alleviate any unknown tax implications and maneuver you through the various phase-outs and restrictions.