After a year of travel restrictions, lockdowns, and social distancing, many individuals are eager to return to their pre-pandemic lives.  For most, getting back to old routines may include a much-needed vacation.  However, many individuals are hesitant to stay in a hotel with other guests close by.  An easy and convenient alternative has presented itself - vacation rental homes.  Short-term vacation rentals have been popularized by home-sharing websites such as Airbnb and VRBO.  These websites facilitate the rental of a variety of spaces, including an entire house/condo or a spare room.

Given the rising popularity of vacation rentals, some taxpayers may be eager to capitalize on their primary residence or second home to generate extra income.  Although renting your home may appear to be an easy task, there are numerous complex tax consequences to consider. 

Dividing Expenses

If the property is being used for both rental and personal purposes, you must divide your expenses between rental use and personal use.

In general, expenses are allocated as follows:

Spare Room/Portion of House:  Expenses are allocated by square footage, or by the number of rooms in the home.  For example: a taxpayer owns a 1,000 square foot house, and rents a 200 square foot room. Therefore, 20% of any allocable expenses are deductible on the Schedule E.

Entire House or Condo:  Expenses are pro-rated by the total number of days that the home was actually rented.

Expenses required to be allocated using the above methods, are any expenses that serve the entire home; for example: utilities, property taxes, and internet.  Expenses specifically incurred for the rental portion of the home, such as repairs to the rental room, do not have to be allocated.

Dwelling Unit is Your Home

If the property is being used for both rental and personal purposes, the tax treatment of the rental expenses, as determined above, will vary if you are considered to be using the property as your home.

You are using the property as a home if you use it for personal purposes more than the greater of:

-        14 days, or

-        10% of the total days the unit is rented to others

Reporting Income & Deductions

Not Used as a Home

If the property being rented is being used personally, but is not considered a home, report all your rental income.  However, you must divide your expenses (see above).  Your deductible rental expenses can be more than your gross rental income, however, see Limits on Rental Losses later. 

Used as a Home & Rented 15 Days or More

If the property being rented is also used personally, and is not considered a home, report all your rental income.  However, you must divide your expenses (see above).  Your deductible rental expenses are limited to your gross rental income. 

14-Day Reporting Exemption

If you use the rental property as a home and it is rented less than 15 days during the year, you are not required to report the rental income and rental expenses related to this activity.

Limits on Rental Losses

If you have a loss from your rental activity, the loss may be limited based on your activity in the property.

If you or your spouse did not actively participate in the rental activity, the loss is considered passive, and can only be used to offset other types of passive income.

If you or your spouse actively participated in the rental activity, you may be able to deduct up to a $25,000 loss from your nonpassive income (wages, interest, etc.)

You actively participated in a rental activity if you or your spouse owned at least 10% of the property and you made management decisions or arranged for others to provide services (such as repairs) in a significant and bona fide sense.

This may create an issue for lessors who use a management company to arrange for services, approve new tenants, approve expenditures, and other similar decisions.

Other Considerations 

Service Fees

You may receive a 1099 form from Airbnb and any other platform that you use to rent your property.

The amount included on the 1099 form may be greater that the amount deposited in your bank account because fees are debited directly by the provider.  Keep in mind, these fees are 100% deductible.

Other Taxes  

You may have to deal with another type of tax: occupancy taxes.   This tax is similar to that of hotel taxes and fees, for operating a short-term rental property.  In some cases, you will need to collect this tax from your renters and submit them to the local government.      

While the rental of a vacation home may appeal to many taxpayers, there are important nuances and tax analyses required to maximize taxpayers' deductions.  If you are planning to take advantage of the current rental market with your vacation home, please do not hesitate to contact your tax advisor at Dermody, Burke & Brown with any questions.

The information reflected in this article was current at the time of publication.  This article will not be modified or updated for any subsequent tax law changes, if any.