Whether you rent out an entire vacation rental property or just a room in your home, you probably already know that vacation rental income can complicate your tax situation. But before we dive deeper into this topic, let’s find out what rental income actually is.
In short, rental income represents the entire amount that you receive from guests for the use of your rental property. An important consideration is that vacation rental income is typically classified as passive income. Unlike active income, passive income results from business activities where you aren’t active on a regular, continuous, and substantial basis. But if you also handle vacation rental management responsibilities, you may be considered an active participant. Whether your rental income is classified as passive or active is important because it can impact the tax rate as well as the deductions you may be eligible for.
As with active income, the income earned from passive activities is taxable. However, that doesn’t mean that you need to pay taxes on all short-term rental income. Even though you must report the total rental income earned on your tax return, you can deduct specific expenses, based on your rental activity. Knowing exactly what you can and cannot deduct is very important because it allows you to keep your taxes to a minimum or even eliminate them entirely. Since tax laws are full of exceptions, here are a few important factors you should be aware of.
The 14-Day or 10% Rule
To ensure that your vacation rental(s) is treated as a rental property so that you can deduct specific expenses, you may use it for personal purposes for a maximum of 14 days or 10% of the days it is rented during the year. If you use your short-term vacation rental for more than 14 days or 10% of the days it is rented, or you rent it to others for fewer than 14 days, the property is considered a personal residence.
In that case, the rental income is not taxable. This means that you don’t need to report it. On the other hand, if you’re using any vacation rental listing sites, like VRBO and Airbnb, it’s important to know that they may report your rental income to the IRS, even if you rented the property for less than 14 days. Additionally, the rental expenses you can deduct must not exceed the amount of rental income. However, you can deduct losses. But there is a catch.
If you’re a passive participant, meaning that a property management company is taking care of your vacation rental, you cannot deduct rental income losses against another type of income. Conversely, if you’re an active participant, you can deduct up to $25,000 per year in losses from your vacation rental, as long as your modified adjusted gross income (MAGI) is $100,000 or less. This deduction phases out for property owners earning between $100,000 and $150,000. If you have a higher adjusted gross income, you’re not eligible for the deduction. These limits apply to all active participants, regardless of whether they’re filing jointly or separately.
Expenses You Can Deduct from Vacation Rental Income
When it comes to a vacation rental, you can deduct a series of ordinary and necessary expenses. “Ordinary and necessary expenses” are the generally accepted expenses in the business and deemed appropriate. For example, you can deduct repairs, maintenance, cleaning, utilities, trash removal, pest control, supplies, management fees, advertising, property depreciation, insurance, HOA fees, mortgage interest, and local property taxes. If you also use your rental property for personal purposes, or you offer one or more rooms in your home, you cannot deduct all of your expenses. In that situation, you need to apportion expenses between personal and rental use.
You can also deduct any repair costs incurred to place your vacation rental in service, even if the property is vacant and doesn’t generate rental income. However, you cannot deduct the cost of improvements. If you have improved your vacation rental property in any way, you can recover the entire cost through depreciation.
Occupancy taxes on short-term vacation rentals are required in some states. The name, rates, and rules of these taxes vary widely from one state to another. As an example, this tax is known as transient occupancy tax in some states and as hotel tax in others. While the host is usually required to collect the tax and submit it to the tax authority, some vacation rental sites will automatically collect and pay this tax on your behalf, if applicable. However, it is up to you, the person renting out the property, to ensure these taxes are paid.
If your tax situation isn’t very complex, justifying the cost of outsourcing your tax preparation to a professional might be difficult. However, doing your own taxes isn’t easy either. Luckily, our lodging management system can make the tax-compliance process simpler. By connecting to your existing business system, our software solution will use a single source of information. This will allow you to streamline your tax filing and reporting procedures significantly. For more detailed information on how our software can help you simplify your tax filing and reporting process, we invite you to get in touch with our professionals today by requesting a demo.
*To ensure you are complying with your state, it is always best to confirm with a tax professional that is familiar with your area.