Vacation Rental Tax Tips: Takeaways From IRS Publication 527
Owning property in a world-class vacation destination can be a dream come true. Some people browse vacation-town homes for sale with the intention of living there full-time, while others invest in part-time vacation homes. One of the best ways to profit from such an investment is to offer short-term vacation rentals. To do so, it's critical to understand what tax implications are present in the area in which you're looking at condos for sale. Recently, IRS Publication 527 has provided new tax advantages for vacation rental owners. Keep reading to learn a few ways you can use IRS Publication 527 to optimize your short-term rental taxes.
What Is IRS Publication 527?
IRS Publication 527 provides specific insight into how taxes are applied to short-term rental properties, including vacation homes. This document helps property owners know how to report their real estate-related income along with expenses so they can complete their federal tax returns. The amount of money you can make from vacation rentals is directly linked to how much you pay in taxes.
Those who own and rent out vacation homes need to report any income they receive on their annual tax return to the IRS. Publication 527 provides the instructions and details of reporting this information to the federal government. It applies to those who are engaging in one of two types of residential rental management:
- A full-time rental of a property, often a person's second home
- The part-time rental of a vacation property when the owner or their family is not using the property
This publication outlines how to report that income and what type of business expenses are applicable to reduce the standard taxation on the property. There are some deductibles available when there is no personal use of the home.
Also, depreciation is included as a topic in Publication 527. It outlines how the property depreciates over time, potentially reducing some of a person's tax obligations.
Is Your Property A Vacation Home or A Rental Property?
To determine how much tax a property owner must pay, the IRS wants to know how much time the owner spends at the property and how much time it is rented out. It is not uncommon for property owners to use their vacation homes from time to time. This is often called a mixed-use vacation property.
Here's the basic breakdown of what qualifies as a rental property. The property owner rents out the home for more than 14 days during the year, and their personal use does not exceed 14 days or 10 percent of the time the property is rented at fair market rates.
Personal use refers to the owner, family members, and others who pay less than the fair market rate to rent out the property. A more specific example of personal use property could be a ski condo that you let friends and family use for free when you're not there.
A property may be classified as a personal residence if it is rented more than 14 days during the year and the personal use is more than 14 days or 10% of the days the home is rented at fair market value.
For any property classified as a rental property, the expenses of maintaining that property, such as a mortgage, property taxes, and others, are divided based on the actual days of rental use. Some special rules apply, such as with ownership to condominiums and cooperatives, where shared costs associated with common space are also considered expenses.
Reporting Income and Deducting Expenses?
In Publication 527, there are specific rules for reporting income and deducting applicable expenses. Most often, the gross income is all amounts received from renting the property. This may include:
- All rents paid, including rent paid in advance
- Lease cancellation payments
- Security deposits retained after a tenant moves out
- Tenant-paid expenses (such as having the tenant pay a maintenance fee or pay a water fee)
- Property or services received instead of rent, such as deducting reducing the rent to accommodate the tenant purchasing something for the property
In addition, property owners may deduct some expenses related to the rental, including the cost of utilities, insurance, taxes, cleaning costs, advertising costs, and improvements that boost bookings. In most cases, rental expenses are not more than the total expenses based on the number of days the property is rented.
More specifically, multiply the total expenses by a fraction to determine this. The denominator is the total number of days the dwelling is used, and the numerator is the total number of days rented at a fair rental price. The resulting number, a percentage, is the total rental expenses for the property that the owner can deduct from their taxes.
What Is Depreciation?
Depreciation may be one way to reduce the amount of taxes paid. It is covered in Publication 527 as it applies to rental properties.
Depreciation is the process by which assets lose value over time. For example, those who own a car know that the value depreciates significantly after it is no longer new. If maintained well, the car's value remains higher than if it is not maintained at all. The same applies to rental real estate.
In real estate, the condition is less critical for determining rent depreciation. The IRS allows the owner to depreciate the property over its expected lifetime. Generally, that is 27.5 years, according to the IRS. Each year the property owner can deduct 3.636 percent of the original cost basis of the property, though this number may change when improvements are made to the property.
Publication 527 outlines how depreciation on a rental property is determined. This is based on the property, the recovery period of that property, and the deprecation method used. It is only allowable to deduct depreciation as it applies to only the part of the property used for rental. Depreciation directly influences how much money your rental earns.
Get the Most From Your Vacation Rental Taxes
For those thinking about purchasing waterfront estates or golf course homes to use as short-term rentals, the correct tax strategies may help to reduce the costs associated with that rental property and allow for profitable long-term opportunities to exist.