Tax Free Rental Income: IRS Rules For Reporting Rental Income on Vacation Homes

Is it possible to collect tax-free income on a vacation rental? The short answer is yes, but your property must meet special criteria.

Typically, income from a short- or long-term vacation rental must be reported on your tax return and is taxable by law. However, many real estate investors don't realize there's a way to generate tax-free rental income—if you have an eligible vacation home.

Here, we explore the unique rules surrounding this scenario and explain how landlords can reap the tax benefits and make a little extra income each year after buying a vacation home.

For informational purposes only. Always consult with an attorney, tax, or financial advisor before proceeding with any real estate transaction.

Rules For Tax-Free Vacation Rental Income

Generating tax-free rental income depends on a few key factors, as specified by the IRS. To meet these criteria, you must have a rental home that is:

• Rented out for 14 days or fewer per year
• Occupied for personal use at least 14 days per year

In this case, and this case only, the rental income you generated for those 14 days or fewer per year will be tax-free. If you adhere to these rules, you don't even need to report this income on your tax return, regardless of the amount of money coming into your bank account.

Is my Home a Personal Residence or Income Property?

While these two stipulations for generating tax-free rental income seem straightforward, in practice, it gets slightly complicated. The IRS has different tax rules depending on whether or not your property is classified as a personal residence or business.

If you use your property for more than 14 days or 10% of the days it's rented out, then it's considered a personal residence. In this case, you deduct mortgage interest and property taxes from your vacation property as you do for your primary home. Remember that if your property is eligible for tax-free vacation rental income, you can't deduct rental losses like you would for an income-producing property.

However, if you use the property for fewer than 14 days or 10% of the days it's rented out, then the IRS considers it a business property. While this means you have to report your rental income and pay taxes on it, the silver lining is you can deduct rental expenses.

Another important consideration for generating tax-free income is how many days during the year your home is used for personal use, versus how many days it's rented out to tenants. If you want to generate tax-free rental income, your property must be used for personal reasons at least 14 days per year. Some examples of personal use include:

• You or a property co-owner are staying there
• A member of your family or any co-owner's family is staying there
• You've given an organization or event host permission to use the house (e.g. for a charity auction or special event)
• You rent the property out for less than fair market value

Personal use does not include days that you spend on your property making repairs or completing maintenance. Whether you spend a weekend, week, or even a month on maintenance, it does not count as your personal use time.

How Can I Rent my Vacation Home Tax-Free?

What does generating tax-free rental income look like in practice?

Imagine this: you own a vacation home in picturesque town and rent it out for a week in August. August is the peak season, and you're able to quickly attract tenants for premium nightly rates. For seven days, you rent it out to a couple on their honeymoon. Four other days go to an older couple that plans to hike at nearby national park during their stay. Finally, your mom and dad have a three-day weekend getaway planned at your home a few days later, free of charge.

As summer comes to an end, you look ahead to the holidays. Every year, you spend Thanksgiving and most of December at your vacation home.

In this example, you rented out your vacation home for 11 days in total—seven days to the honeymooning couple, and four days to the hikers. The three days your parents spent at the home count as personal days.

Meanwhile, your personal time during Thanksgiving and most of December exceeds 14 days per year, at over one month. As a result, your vacation home qualifies as a tax-free rental because you rented it out for fewer than 14 days, and used it for personal reasons for over 14 days. That means the rental income you generated over those 11 days is tax-free.

Stay On Top of Vacation Rental Taxes

As a property owner, it's important to stay informed about how tax laws affect your vacation home to prepare for tax season and explore whether or not you're eligible for tax-free rental income.

As previously mentioned, how your property is classified on tax documents is extremely important. Your home must be treated as a personal residence—not a rental property—on your tax return if you hope to generate tax-free income.

Remember: if your vacation home qualifies as tax-free, that means you can't deduct expenses, including maintenance, insurance, utilities, or depreciation. You can deduct your real estate taxes on a Schedule A form (for personal, itemized deductions), but shouldn't use a Schedule E form that landlords use to itemize rental property expenses. By staying up to date with real estate tax laws and ensuring your property qualifies, you can avoid missteps and reap the rewards of tax-free income

For informational purposes only. Always consult with an attorney, tax, or financial advisor before proceeding with any real estate transaction.