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While renting out a vacation home can help defray costs and provide certain tax breaks, it may also raise some complex tax issues.
Q. I'm in the process of purchasing a vacation home in North Carolina that I plan to rent out when my family is not using it. What are the tax implications of such an arrangement?
A. Many physicians who own vacation homes often consider the possibility of renting out the property for part of the year in order to receive potential tax benefits. While renting out a vacation home can help defray costs and provide certain tax breaks, it may also raise some complex tax issues.
Tax-free rental income. If you rent out your vacation home for fewer than 15 days during the year, the rental income is received on a tax-free basis and does not even need to be reported as income on your tax return. You can still claim deductions for property taxes and mortgage interest, just as you do with your primary residence. However, you won't be able to deduct any rental-related expenses, such as maintenance, property management fees, or assessments. In addition, if your rental-related expenses exceed the income that you receive from renting your vacation home, you are not allowed to claim a tax loss.
Pure rental property. If you intend to rent out your vacation home for more than 14 days a year, the tax rules become much more complicated. If you and your family don't use the property for more than 14 days a year, or 10% of the total number of days it is rented, whichever is greater, your vacation home will qualify as a rental property and not as a personal residence.
When renting out your vacation home for more than 14 days during the year, you must report all rental income you receive. You are allowed to deduct certain rental-related expenses, including homeowners' insurance, depreciation, utilities, property management fees, repairs, and condominium association fees. You are also allowed to take a loss on the ultimate sale of the rental home. How much you can deduct for expenses will depend on how often you and your family use the property.
Income and deductions generated by rental property are treated as "passive," thus making them subject to passive activity loss rules. As a passive activity, rental property losses can't be used to offset income or gains from "non-passive" activities, such as wages, dividends, interest, or gains from the sale of stocks and bonds. They can only be used to offset income or gains from other passive activities. Passive losses you can't use one year may be carried forward to future years.