There are numerous advantages to investing in vacation homes: the occasional getaway, the passive income, even the extra space. But, perhaps the biggest perk is the many vacation rental tax deductions available as a property owner.
From operating expenses to refurbishment costs, there are many different types of vacation rental property expenses owners can write off and use to reduce their tax liability. However, as with anything related to tax code, it is vital to play by the rules and follow the guidelines established by the IRS.
One common mistake by those who own vacation properties with the purpose of renting them to tenants, is to over-deduct what the IRS deems “reasonable.” In fact, the first key lesson when learning how to buy a vacation rental, or mastering any number of rental property investment tips, is not finding the best location for a rental property but instead learning how taxes work regarding these homes.
To keep you in compliance with the IRS, and to help you make use of all applicable deductions, take a look at what you need to know regarding vacation rental property taxes below:
(Note: This information is intended for educational purposes only and should not be considered financial advice. Please mind your due diligence before engaging in any tax strategy.)
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Vacation Home Tax Rules 2021 & 2022
Not all vacation homes are created equal. Not just in terms of quality, though that’s often true, but in terms of how the IRS views your vacation home. It comes down to a basic question: how much time do you plan to spend in or around your vacation home?
There are three basic vacation-home tax scenarios:
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Your property is rented to tenants on a short-term basis.
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Your property is a primary residence for you, but you rent it out when not on the premises.
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Your property is rented to others for a majority of the year.
Each of these scenarios has its pros and cons, from a tax standpoint, and they often have more to do with your life situation than any tax benefit that may be derived.
The key is to have a strategy for how you plan to use your vacation home and ensure you meet all tax guidelines to avoid getting hit with a stiff tax bill later on.
Short-Term Vacation Rental
Of the many vacation rental strategies out there, this is the most common. You have a primary residence, or perhaps a second home, and you’d like to rent out this home for the odd day here-and-there to generate extra income.
Well, before you pop open the champagne and start purchasing items from your Amazon wish list, it’s important you know exactly what you can and can’t do with short-term rentals from a tax standpoint:
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The sweet spot: If you’re able to rent your property for two weeks (14 days) or less, you’ll get to keep all of the rental income tax-free. No matter how much you took in. This is perfect if you have a location near a yearly event—such as a conference or festival—where you can charge premium rates for a short duration.
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Be organized: Keep good records, especially if renting more than 14 days per year. From a tax perspective, the more income you bring in, the more complicated things get. You’ll need to distinguish between personal use and rental use with all your expenses. And know, upfront, you can’t claim “losses” on a rental used this way.
Investment Property Vacation Rental
If you’re interested in using your vacation home as a full-time rental, or nearly full-time rental, you’ll want to keep the following in mind:
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14-day rule: To have your property viewed as a rental property, you need to limit your personal occupation of the property to two weeks or less—or 10% of the time it’s rented—over the course of a year. This is calculated on an annual basis, not prorated, so you either qualify, or you don’t in each given year.
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Income is income: Rental income is taxable, but so are many of the costs connected to a rental property. (See below.)
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Real estate business structure: If you’re able to reduce your active participation in a property, such as having someone else manage the property for you, and have the right business structure in place, such as a real estate LLC, a huge set of tax benefits may be available to you.
Lodging Taxes vs. Income Taxes
Vacation rental tax deductions specifically relate to federal income tax. It is important to note that income taxes differ from lodging taxes. Lodging taxes are paid by guests when renting short-term accommodations. Income taxes are based on your income and paid by you to the government.
As a host, you are not responsible for paying lodging tax. However, you are responsible for lodging tax collection for the appropriate state and local tax authorities. Unfortunately, there are no deductions you can claim for lodging tax.
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11 Common Vacation Rental Property Tax Deductions
We’ve talked a lot about what you need to do to qualify for vacation rental tax deductions and how to define your property so the IRS knows how to estimate your tax liability accurately. Now, it’s time for the fun part: what you actually get to deduct.
Of course, this will depend on your particular property and what local laws apply to you, but here are a few of the most common and reasonable expenses you can deduct as defined by the IRS:
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Taxes: Property taxes can actually be deducted as business expenses, with relatively few limits. If your property is officially designated as a vacation rental property, this deduction applies to you.
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Repairs: No matter how much you try to avoid maintenance issues, they can and do happen. The good news is, repair costs (including supplies and labor) count as a vacation home tax deduction.
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Utilities: Did you know the cost of keeping the lights on in your rental property can be deductible? Utilities, including water, power, and internet, can lead to substantial deductions.
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Loan interest: Depending on how you financed your vacation rental, the mortgage interest may be deductible. Because you are renting the property out, this interest technically qualifies as a business expense
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Property management fees: The fees associated with property management services, like tenant placement fees or other operation costs, can be classified as deductions.
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Insurance fees: A crucial step to operating a vacation rental property is taking out the right insurance policies. While insurance fees can increase your monthly operational costs, they do count as deductions.
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Cleaning and maintenance costs: Similar to repairs, the cost of general cleaning and repairs can be deducted as well.
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Legal fees: Any professional costs can be deducted from your rental income as well. This refers to attorney and other legal fees, accounting costs, and even general bookkeeping services.
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Transportation expenses (including auto and air): Among the various vacation home tax deductions is the opportunity to deduct travel expenses to and from the property. If your reasons for travelling are business related, many travel costs are actually deductible. However, this is always where I tell investors to be careful.
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Advertising: Marketing your rental property counts as a business expense. If you pay to list the property on Airbnb or VRBO, for example, the cost of listing can be deducted from your taxable income.
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Depreciation: The normal wear and tear that occurs on a property can lead to one of your biggest deductions as a real estate investor. depreciate the value of your asset, the vacation property, over a specified set of years, even if the “value” of the property actually goes up. To learn more about rental property depreciation, be sure to read this comprehensive guide.
Do note that each of the different vacation rental strategies, full-time and part-time, have varying levels of tax deduction regulations, especially when you include local taxes. Be sure to contact a tax professional to help you navigate this process.
5 Secret Vacation Rental Property Tax Deductions
With all of the responsibilities associated with operating a vacation rental property, it can be easy for things to fall through the cracks. However, I stand by the fact that tax breaks are among the best advantages available to real estate investors. That’s why when it comes to potential deductions, it’s crucial to make sure you don’t miss anything. Here are a few more tax rules for vacation rental property that might save you in the long run:
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Property Improvements: Taxes can get tricky when it comes to renovation projects, but there are some property improvements that can actually be tax-deductible. In late 2018, changes made to Section 179 made projects relating to fire protection, security systems, roofing, and some HVAC updates tax-deductible. To learn more about the specificities of this update, be sure to cite the IRS guidelines.
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Credit Card Interest: Property owners who use credit cards to cover business expenses may find the interest to be tax-deductible. As you might expect, there are strict laws differentiating between personal and business expenses, but when used correctly, this deduction could save you a little extra money each year.
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Home Office: While there may no longer be home office deductions for employees, business owners can still take advantage of this benefit. Depending on how you operate your vacation rental, you could be eligible for several home office deductions. This includes the cost of home office equipment, supplies, and even a portion of monthly utilities.
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QBI Deductions: If your rental property is considered a business, the QBI deduction could save up to 20 percent of your income. The deduction is for small business owners who perform at least 250 hours of serve for the vacation rental property. Thorough records and time keeping are required to receive the deduction, but when applied correctly property owners could their reduce overall taxes.
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Passsive Losses: Real estate losses are considered passive losses. This means that they are usually not able to be deducted from your taxes at the end of the year. However, there is an exception that may allow you to get around this standard rule. The exception occurs when your Adjusted Gross Income (AGI) is less than $100,000. If this is the case you may be covered for up to $25,000 in deductions each year. Passive losses that don’t fall into this category can be saved and used against your taxable profit when you sell the property.
Summary
On the best of days, the vacation rental tax code is confusing and overwhelming—and something difficult to cover in any depth in an article of this size.
As long as you have a clear vacation rental strategy and use a tax professional to help you check all of the boxes, you’ll have a great chance at finding each of the vacation rental tax deductions available to you. And that’s almost better than a getaway.
Which vacation rental tax rules surprised you? Share your reactions in the comments below.
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