An owner of a second home that is both rented out and put to personal use at different times in any given year should bear in mind the considerable differences in income tax liability that flow from how the two types of uses are allocated. Each year, for tax purposes, the home will be considered as either a residence or rental property, with important differences in the resulting tax calculations. The bottom line is that treatment of the home as rental property is advantageous for the owner, and keeping down the personal use of the property allows it to be so characterized.
If personal use of the second home is less than the greater of 14 days or 10% of rental days, the home will be considered rental property. Flowing from this classification is the ability to deduct repairs, maintenance, insurance, and depreciation costs. In addition, if the expenses exceed the income from the property, the taxpayer can deduct the loss, subject to passive loss rules. Generally, passive losses up to $25,000 may be deducted if the adjusted gross income (AGI) is under $100,000. The ability to deduct passive losses declines as the AGI increases, eventually phasing out at an AGI of $150,000.
If the owner exceeds the personal use threshold for treatment as rental property, the home is treated as a “residence.” In that case, the owner can deduct expenses only up to the amount of rental income, and no loss deductions are allowed. In addition, before there can be any deduction for operating expenses, the owner must use up the property’s share of mortgage interest and property taxes to offset the rental income, which effectively wastes deductions.
In short, if as an owner of a second home you rent the home for a substantial part of the year, but you also just cannot stay away from the place (that’s why it’s called a vacation home, isn’t it?), enjoy the time away but be prepared for tougher treatment by the IRS.