Vacation Home Tax Treatment

March 2, 2023  | By David Lowe

If you plan to own a vacation home, you probably already can envision your dream site. It could be a cozy mountain chalet, a relaxed beach house within earshot of the surf or a luxurious apartment overlooking the New York City skyline.

You probably also have thought of whether to treat the property strictly as a second home, or whether to rent it out. Maybe you plan to spend lots of time there and rarely host tenants. Maybe you want to list it on Airbnb most of the year but reserve two weeks for yourself. Perhaps you expect about a 50/50 split of family use versus non-family use.

Each of those options could fulfill your vision for your home away from home. However, each one also has specific federal income tax consequences. While this is not tax advice (please consult your tax advisor to discuss your specific situation), here is a general overview of how the IRS treats vacation homes.

What Counts As a Vacation Home?

Definitions matter in tax planning. When determining if a property is a vacation home for income tax purposes, “dwelling unit” is a key term. The IRS considers each of these to be a dwelling unit:

• House
• Apartment
• Condo
• Mobile home
• All structures or other property that belong to the dwelling unit
• Boat (Wow, there are lots of houseboat vacation destinations across the United States!)

Hotels, motels and inns don’t count as vacation homes. What constitutes a hotel, motel or inn? The IRS definition is an establishment that is “regularly available for occupancy by paying customers and isn’t used by an owner as a home during the year.”

Mostly Personal Use

When your vacation property mostly serves as a family getaway, the tax treatment is fairly straightforward – and favorable. If you use the home as a residence and rent it out for no more than 14 days in a year, all of the rent is excluded from income. That certainly simplifies things. Plus, tax-free income is a nice bonus.

For online estimates, I checked beach house rentals for two adults in Port Aransas, Texas. Mid-February rates are about $125 per day. In mid-July, income of $300 per day is very feasible for nice properties. Multiply the $125 per day February rate by 14, and you could earn $1,750 of offseason income with no tax liability. If your family doesn’t mind skipping two weeks of summer use (maybe you want to avoid crowds), you could make $4,200 tax-free.

In extremely high-end markets, it is possible to receive even larger amounts of tax-free income. As Kiplinger notes, the government does not limit how much an owner can charge under the 14-days-or fewer exception.

Tax expert Jeff Socha outlines ways to use this strategy to your advantage. As he explains (starting at the 20:30 mark on this podcast), limited home rental days can be effective for entrepreneurs who use their home for their business activities. It also can work for W-2 employees who may want to rent out their own home while they are on vacation! Remember, this is tax-free money without the administrative headache of reporting the income.

In any case, the income from limited rental activity is very unlikely to offset all the costs associated with owning a second home. But if you just want to put your family place to use on a limited basis when you’re away, it can be a nice side benefit.

If you rent for fewer than 15 days, don’t deduct costs as rental expenses. Most costs, that is. You still may claim the typical homeowner deductions for mortgage interest, property taxes and casualty losses (such as fire or hurricane damage).

Primarily rental

What if you frequently rent out the property? In that case, the number of personal days becomes important. That’s because the amount of personal use determines the deductibility of rental-related expenses.

If you rent out the vacation home 15 days or more per year, you must report the income.

Now, to the expenses. The IRS considers the property a rental – triggering favorable deductibility rules for expenses – if the personal use days do not exceed a 14 day/10 percent limit. The maximum amount of personal use in a year is whichever is greater: 14 days or 10 percent of the total rental days for the year.

As long as personal use doesn’t exceed the 14-day/10 percent limit, losses are deductible up to $25,000. The ability to offset rental losses against other income depends on whether you are an “active participant” in the rental activity. It also is subject to modified adjusted gross income (MAGI) limits. For more details, see this IRS site, under the header “Special Allowance for Rental Real Estate Activities.”

Here’s a quick example. If you own a cabin in Durango, Colorado and rent it out 200 days a year, your family can use the cabin for 20 days in the calendar year while keeping the favorable deductibility rules.

If, on the other hand, you only host tenants for 60 days during ski season, you would need to limit family use that year to 14 days if you want the ability to write off losses. (Remember, the limit is whichever is more: 14 days or 10 percent of the rental days. In this case, 14 days exceeds the 10 percent amount – which would be six days.)

Mix of Personal and Rental Uses

If personal use exceeds the 14-day/10 percent limit, you still may deduct rental expenses. However, those expense deductions only can offset rental income. They cannot create a tax loss. Rental expenses that exceed income from the property may carry forward to the next tax year to offset income.

For example, let’s say you rent out your Colorado vacation home for 60 days each year and also use the cabin for 60 days of family getaways each year. In this case, personal use exceeds both the 10 percent threshold (six days) and the 14-day limit.

Imagine you had $10,000 of expenses attributable to rental use but only $9,000 of rental income. The first $9,000 of expenses could offset the rental income, but the rest of the expenses could not create a loss. Instead, the remaining $1,000 of expenses could carry forward to the next tax year.    

What Counts as a Personal Use Day?

The preceding details raise the question of how the government defines a personal use day. Obviously, count any day the owner uses the property purely for his or her pleasure. That’s not all, though. In fact, in the IRS’ eyes, each of the following uses also count as personal days:

• Use by a family member. This includes the owner’s spouse, brothers and sisters, half-siblings, parents, grandparents, children and grandchildren.
  • There is an exception if the family members use the dwelling unit as their main home and pay a fair rental price. 
• Free or discounted rent. Giving a friend or colleague a great deal is a generous gesture. If you find fulfillment from being a gracious host, go for it. Just know that you’ll need to count the unrelated party’s use as though it were your own personal use.
  • The IRS says the rate is not a “fair rental price” if it’s substantially lower than what the owners of similar nearby properties charge. The IRS advises owners to consider use, property size, the condition of the dwelling, furnishings and location when deciding if a price is “fair” compared to neighboring properties’ rates.
• Property rental swap. See the IRS’ Example 4 under the “What is a day of personal use?” heading. If, for example, you rent your Manhattan condo to Amanda, and she lets you rent her lake house in return, the days Amanda rents your condo count as personal days for you. It doesn’t matter if you each charge at the full market rate. This arrangement still counts as personal use.
• Charitable donations. This brings to mind my days on the Lampasas Boys & Girls Club fundraising committee. For the auction – organized, in true Texas style, as a swanky barn dance – several property owners donated vacations at their beach houses, hunting lodges or Hill Country bed and breakfast venues. The IRS states that such donations count as personal use (for the donor) when the “purchaser” at the charitable fundraiser uses the vacation property.
• Use by any person who owns an interest in the property.
  • This means a co-owner’s vacation use can affect you. See Example 1 under the “What is a day of personal use?” heading. The IRS notes that if a co-owner uses a property for two weeks, you are considered to have two weeks of personal use (even if your family never visits the place during the year).
  • An exception is if you rent your interest to another owner as his/her primary residence – and that co-owner pays a fair rental price under a shared equity financing agreement.

Good news! There is a perfectly legal way to visit your vacation property but not have to count the day as personal use. Just plan to work “substantially full time” throughout the day “repairing and maintaining (not improving) your property,” as the IRS says here. (Scroll down under “Dwelling Unit Used as a Home.”) The IRS notes that the day does not count as personal use “even if family members use the property for recreational purposes on the same day.”

Here’s a scenario. You spend a few hours in the morning nailing down loose boards on your beach house deck and stairs. You cool off in the waves for a bit, break for lunch, then work the rest of the day to replace damaged flooring inside the house. You treat yourself to an early evening boat ride, then enjoy fresh seafood at a waterfront restaurant. You cap off the night by sipping a glass of wine while listening to the waves from your deck. (After all that activity, you probably sleep very soundly, too.) It’s not a bad day’s work – and you haven’t dipped into your yearly allowance of family vacation days. The next time you come to the beach house, you can focus solely on having fun.

As Kevin Smith, CFA points out in this video and podcast (about the 2:15 mark), some property owners consider it a big hassle to trek to their vacation home for maintenance work. That may be especially true if the property is far away or needs extensive repairs. On the other hand, if your schedule permits and you enjoy the work, it could give you a tax-favored excuse to visit a place you enjoy. Feel free to relax and enjoy the scenery once the day’s work is done!

Dividing Expenses Between Personal and Rental

To deduct expenses for vacation homes that you rent out, divide the expenses between rental and personal use. In other words, add total rental days to total personal days, then figure what percentage of those total days were rental versus personal. 

Do count a day as a rental day any time you charge a fair rental price – even if you used the property for personal reasons during the day. (This is different from the rule for determining whether the dwelling unit is used as a “home.”) Also, the day only counts as a rental day if a tenant actually rents the property. Exclude the days the property was listed for rent but nobody booked the dwelling.

For example, imagine that you list a vacation property for rent for 305 days of the year and use it personally for 60 days. You manage to rent out the property at the full market price for 180 days, and it is unoccupied the rest of the year.

Don’t count the 125 days when nobody used the property. Add the 60 personal days to the 180 rental days for a total of 240 days of use. Rental use equates to 75 percent (180/240).

For a very detailed look at calculating deductions for a mixed-use rental property, scroll to Worksheet 5.1 – toward the bottom of this IRS site.

Calculations and allocations can get complex, so be sure to consult a tax advisor for advice about your specific situation.

Learn more with an online tax tool

Ready to find out more about the taxation of your rental property? Consider using the IRS’ Interactive Tax Assistant tool (estimated completion time: 15 minutes). By answering a series of short questions, you can find out if your residential rental income is taxable. The tool also can help you determine if you may take tax deductions for expenses related to the property. The tax code itself is complicated, but these questions are not. If in doubt about what a term means, click the links to open pop-up windows with short, plain-English definitions.

The IRS notes that the tool’s answers “do not constitute written advice in response to a specific written request of the taxpayer.” Nevertheless, the online tool is a good starting point for general information about your property. The answers you receive may provide helpful talking points to discuss in depth with your financial planner and/or tax advisor.

There are many considerations when thinking about owning a vacation property. Taxes are just one of the important factors to evaluate. Above all, if you decide to own a vacation home, enjoy the experience. Your dream getaway can be the perfect place to make great memories!