How to maximize the tax benefits

The summer rental season is about to kick off. If you own a vacation home in a resort area that you rent out while your family is not using it, you may be in line for valuable tax deductions. In fact, you might even qualify for a tax loss on the deal, but you must be careful to observe the complex tax rules.

To offset the income you receive from tenants, you can typically deduct the costs attributable to the rental, including mortgage interest, property taxes, repairs, utilities, insurance, etc. But there is a limit to this tax generosity: Under the passive activity loss rules, you can use losses from a rental activity only to offset losses from other passive activities.

However, if you are an active participant in the rental (e.g., you make management decisions), the tax consequences depend on your income level and the extent of your family’s personal use. There are three basic rules to follow:

  1. If your income does not exceed $100,000, you can use the loss to shelter up to $25,000 of your salary and other income as long as you keep your personal use to a minimum. Your family’s personal use cannot exceed the greater of 14 days or 10% of the rental time. On the downside, when you keep your personal use below these limits, you lose a portion of your mortgage interest deduction (the portion allocable to your personal use).
  1. If your income exceeds $150,000, the tax law says you cannot qualify for the $25,000 loss write-off. Basically, your total rental deductions cannot exceed your rental income, regardless of the amount of your personal use. However, if your personal use is greater than 14 days or 10% of the rental period, you are entitled to an additional deduction: the portion of your mortgage interest you do not claim as a rental expense.
  1. If your income is between $100,000 and $150,000, things are not as clear-cut. The $25,000 loss write-off is gradually phased out in this income range. The closer you are to the $150,000 level, the more likely it is you will get little in the way of a loss write-off. So you will probably want to increase your personal use—the same strategy for those with incomes above $150,000. This way, you will be able to deduct more of your mortgage interest.

Conversely, if you are closer to the $100,000 level, most of your loss write-off will be intact. Therefore, try to keep your personal use below the 14-day or 10% mark.

Note: There is a unique tax opportunity if you rent out the home for two weeks or less during the year. You do not have to report any income or expenses for this short period on your 2017 tax return. As a result, all of the rental income is effectively tax-free.

The tax rules in this area are extremely tricky, and it is easy to slip up. Do not hesitate to seek professional assistance with respect to vacation home rentals.