Vacation Homes

Tax Tips for Vacation Home Owners
By Tracy Byrnes
TheStreet.com Contributor
6/22/2007 12:39 PM EDT

I would love to own a little place at the beach someday. Of course, since I'm a Jersey girl, it would have to be down at the Jersey shore. But nothing too big, just something comfy and close to the water that my kids and I can enjoy
Sounds dreamy to me.

But these days, folks with summer homes are not so enamored.

With increasing energy costs, rising adjustable-rate mortgage payments, and the high price of gas, many folks are finding that sweet little escape at the beach is nothing but a money pit. As a result, many vacation-home owners have no choice but to consider renting out the place for a few weeks to help defray the costs.

Once you get over the notion that a stranger will be sleeping in your bed and using your toilet, it's actually not all that bad -- at least on the tax front.

A Freebie From Uncle Sam?
Depending on how long you rent out your home, the rental income may actually be tax-free.

"If you rent your vacation home for no more than 14 days during the year, the rent you receive is tax-free," says Bob Scharin, RIA senior tax analyst from Thomson Tax & Accounting, a part of the Thomson Corporation (TOC - Cramer's Take - Stockpickr - Rating).

And you don't even have to report that income on your tax return. So take the money and run! Even better, you can still can deduct your mortgage interest and real-estate taxes on "Schedule A" -- Itemized Deductions, as if you never rented out your home.

Just don't go thinking you're a landlord now. If you rent your home out for 14 days or less, you're not and you therefore cannot deduct any rental expenses.

This tax rule is nothing new. You can also rent out your principal residence for up to 14 days and pocket the money too. So if you're going on vacation anytime soon, consider renting out your home and getting your vacation paid for.

But I Want to Be a Landlord!
If you instead decide to rent out your fabulous little summer place for more than 14 days, then feel free to call yourself a landlord.

And introduce yourself to "Schedule E" -- Supplemental Income and Loss, because you'll need to report the income you receive from rentals that exceed 14 days. While you'll now owe tax on that money, you'll also be able to deduct some corresponding rental expenses.

The rules for deducting rental expenses are not entirely straightforward -- no surprise. First, you'll need to quantify the time you rent the house vs. The time you live there.

Then decide which camp you fall into:

Do you use the place as a vacation home and rent it on occasion?
Or do you rent it out mostly, and sporadically use it for personal use?

Here are the arcane technical rules for the first scenario: Your vacation home is rented for more than 14 days and your personal use exceeds the greater of 14 days, or 10% of the rental days. Translation: You use it more than you rent it.
In this case, the rental portion of your deductions also should be reported on Schedule E. Things such as mortgage interest, real-estate taxes, rental agent fees, cleaning and maintenance costs, insurance premiums, utilities and depreciation are just some of the things you can list. Basically anything out-of-pocket that helps you keep up the home can now be deducted.

But since you use the house for pleasure more than "business," your expenses cannot exceed the gross income you make from rents. However, any excess deductions can be carried over to a subsequent year.

The part of your deductions that represent the personal use of the house still should be reported on Schedule A. In very simple terms, let's presume that only 15% of the usage is rental. Then only 15% of the mortgage interest goes on Schedule E. The remaining 85% should be reported on Schedule A.

Now, if you answered "yes" to the second question, and the home is more of an rental property (not a fun-family beach home), then it should be treated accordingly(The technical rule is ridiculous: It says that if you personally used your vacation home for fewer than the greater of 15 days or 10% of the days it was rented out, it is not considered a residence. Huh?)

Basically, if you don't fall under the first scenario, your home is probably a rental property. That means your deductions are no longer limited to your rental income, so the sky's the limit. However, they still must be allocated between your personal and rental use so the appropriate portion must still go on your Schedule A. The upside is that the piece that's allocated to your rental income can be unlimited.

Big note: now that it's a rental property, you can't deduct your mortgage interest on Schedule A any more. That's because it's not a second home for you and your family -- it's an investment property.

And one more big tip: "If you are going to rent any of your homes for more than 14 days, just be sure to keep good records of both your rental and personal-use pattern, and the expenses you incur," Scharin advises.

April is a long way off, so get your documentation now. And then, if Uncle Sam ever comes knockin', you have backup.

So enjoy your beach house. Rent it out and make some money. Just be sure to change the sheets between visits.