IRS Publication 527: 4 Tips to Make More Back On Vacation Rental Taxes
Owning a vacation rental opens the door for an income stream. Many areas are popular tourist destinations offering outstanding amenities that draw people in routinely. When renting out a property, it's important to understand that a short-term vacation rental is a business. As such, there are tax implications to allowing people to use the property. All rental income must be reported to the IRS. In some cases, expenses may reduce what is owed on tax returns each year.
While it's always best to speak to a tax professional to ensure information is the most up-to-date, there are several aspects of taxation related to vacation rentals that property owners should be familiar with themselves. Keep reading to learn more about what vacation rental owners should know about Publication 527.
What Is IRS Publication 527?
Much of what applies in rental tax requirements fall under Publication 527 from the U.S. Department of Treasury. The IRS updates this guide annually based on any changes in tax law for that year.
This valuable tax document helps residential property owners understand their tax obligations for any rental income they have and the related expenses in federal tax law. It applies to situations in which people engage in two types of residential rentals:
- The full-time rental of a second home (not the owner-occupied property)
- A part-time rental of a vacation home when the property owner or a family member is not using the property
This document lays out how to report all income from a short-term rental. It also outlines how the property owner can deduct rental expenses when there is no personal use of the property by the owner. The document covers depreciation of the property as well as various situations, such as what to do if the property is used for not-for-profit goals.
For those considering starting a short-term rental business in a particular city, keep in mind this document is just focused on federal law. Local and state legal implications and tax implications may apply as well.
Is Your Property A Vacation Home or A Rental Property?
Different tax implications exist for those who rent out a vacation home and those who have a rental property. The amount of time spent in the property is one of the biggest concerns for the IRS. Specifically, this helps determine if the property is classified as a personal residence or a rental property. For it to be a rental property, it should fit these requirements:
- It's rented out more than 15 days during the year
- Personal use during that year doesn't exceed 15 days or 10% of the days the home is rented at fair market rates, whichever is higher
Personal use describes the use of the home by the owner or certain family members, and sometimes others, who use the property at less-than-fair market rental rates.
The property is considered a personal residence if:
- The property is rented out for more than 15 days during the year
- Personal use of the property is more than 15 days or 10% of the days the home is rented at fair market value, whichever is greater
Vacation homes classified as rental properties allow for mortgage interest, property taxes, and other expenses to be allocated between the rental and personal use based on the number of days the property is used for personal use or a rental.
Keep in mind that some properties, such as condominiums and co-ops, may have special rules. In condos, for example, if an owner rents the condo to others, it may be possible to deduct expenses related to any common area maintenance costs paid by the owner.
Reporting Income and Deducting Expenses?
Under IRS law, a property owner must report all rental income, which includes all gross income from all amounts received as rent. "Rent" includes any type of payment received by the property owner for the use or occupation of the property. This may include:
- Rental payments and any rent paid in advance
- Tenant-paid expenses
- Lease cancellation payments
- Property or services received as rent, such as the tenant doing work at the property in exchange for rent
- Security deposits retained
When it comes to expenses, many types may apply to taxes and reduce what is owed. Residential rental property owners may deduct expenses such as the following, in most cases:
- Advertising costs
- Insurance costs
- Mortgage interest paid
- Utilities paid by the owner
- Taxes paid by the owner
- Cleaning and maintenance costs
Part-time rental property owners need to break down and treat those expenses on their taxes. Rental expenses cannot be more than the total expenses multiplied by a specific fraction. That fraction is the number of total days rented at fair rental price divided by the total number of days the unit is used. Short-term rental home improvements generally can't be deducted, but owners can recover some improvement costs via Form 4562.
What Is Depreciation?
The IRS Publication 527 also breaks down the implication of depreciation. This is a capital expense. It allows property owners to recover the cost of an income-producing property. Three factors determine how much the property owner may deduct each year for depreciation: the property's cost basis, the property's recovery period, and the depreciation method selected.
The IRS also outlines what type of property can be depreciated. This includes property owned by the individual for income-producing activities and has a useful life of more than one year.
It's not possible to depreciate land or some types of property, such as property placed in service and then sold in the same year.
Managing Taxes Is an Important Step
Understanding the tax implications of short-term rentals takes a significant amount of effort for many people without investment experience. A tax professional can help minimize risks in making mistakes on these documents. Keep in mind that many vacation rentals can be lucrative even if significant taxes are applied to them.