Most rental property owners don’t use their homes for personal use; it’s strictly a business operation and should be reported on Schedule E of the tax return.
However, there are some folks who own a vacation destination property and rent it out when not in personal use, and the tax rules are more complicated and specific.
The rental property doesn’t have to be a standard four-wall dwelling; it can be a boat, a recreational vehicle or even a room in your home.
For folks who own mixed-use vacation properties, they should report it on Schedule E of Form 1040 just as you would with a regular business operation. However, if you use the property as your residence and rent it out for less than 14 days during the year, you don’t have to report the rental income.
If you occupy the property for more than 14 days or more than 10% of the days that it is rented-- whichever is greater--the property is considered your residence and the use is considered personal. This applies to use by relatives, co-owners or any others you rent to at less-than-fair-market value. Any use by you or them is considered personal use and the occupied days must be included as factors in the equation. If this is the case, then your deductible rental expenses cannot exceed your rental income. You therefore lose the tax advantage of taking a loss on the rental against other income on your tax return. Keep in mind that you may deduct mortgage interest and property taxes on Schedule A for your main home and a second home
Here’s an example, say you own a cottage in Hilo and you stay there for seven days. Your Aunt Clara also stays for three days rent free, and then you rent it to your cousin at half price for five days. Later, you rent it out at fair-market value to vacationers for 160 days. Personal use is 15 days and you will show the rental income and expenses, but only to the extent of expenses on your tax return because personal days exceed 14.
You do not have to include any days that you stayed at the rental property to perform routine repairs and maintenance--even if friends or relatives joined you for recreational purposes. So for example, you traveled to your beachside villa with a couple of buddies. While they sun bathed, you repaired the bathroom toilet, shampooed the carpets and serviced the air conditioner. These days should not be considered personal days.
Let’s say that you live in a vacation destination and you rent out a room in your house to tourists. If you never use this room for any other purpose, then the rental is not considered mixed use. It is essentially a bona fide Schedule E rental which means you will report the income and are entitled to deduct all expenses including depreciation.
Vacations aside, note that if you rent any part of any rental to a relative at less than fair-market value, you cannot deduct expenses in excess of rental income. So if you own the house next door which you rent to your mother at less than fair market value, you will never be able to enjoy a loss on your tax return against other income. You are required to show the income less expenses to the extent of that income.
Bonnie Lee is an Enrolled Agent admitted to practice and representing taxpayers in all fifty states at all levels within the Internal Revenue Service. She is the owner of Taxpertise in Sonoma, CA and the author of Entrepreneur Press book, “Taxpertise, The Complete Book of Dirty Little Secrets and Hidden Deductions for Small Business that the IRS Doesn't Want You to Know.” Follow Bonnie Lee on Twitter at BLTaxpertise and at Facebook.