The growing popularity of companies like Airbnb and Vacation Rentals By Owner (VRBO), has many Americans considering renting out their homes, or even specific rooms in their homes, in hopes of making some extra money. The decision to rent may lead to additional money—but also may lead to additional taxes. Or does it? If your rental meets the qualifications for short-term rental income, then the rental is not taxable, but all other rental income is reportable on your tax return.
Meeting the Short-Term Test
If taxpayers meet the short-term test, also known as the 14-day rule, they are not required to recognize the income from the rental period, but also may not deduct incurred expenses—e.g., cleaning, repairs, supplies, mortgage interest, and utilities. Meeting the 14-day rule occurs when:
- You rent the property for no more than 14 days throughout the year, AND
- You use the rental property yourself for more than the greater of 14 days during the year, or 10% of the total days you rent it to others.
In this best-case scenario, you get to keep the money you made from the rental period and not pay the taxes. Room rentals work in the same way as renting out your whole home.
Short-term rentals are popular when the Super Bowl, music festivals, or other large events are in the area. The 2017 tax year should see a rise in short-term rentals thanks to the August 21 occurrence of the once-in-a-lifetime Total Solar Eclipse. In preparation for the eclipse, thousands of Americans who lived within the path of totality either rented their homes, or rooms in their homes, to people from all over the nation.
Reportable Rental Income
If your rental is not considered short-term, then the income and related expenses generated from the property must be reported on your tax return. How the income is classified is based on the way in which the rental is used. Most home rentals are considered passive activities and are reported on Schedule E of the tax return. This is important, because if you have a passive loss, you generally may only offset it against an activity that generated passive income.
However, a passive rental activity loss deduction of up to $25,000 can be taken for taxpayers whose classification is single or married filing jointly (additional rules and limitations apply for married taxpayers filing separately); who actively participated in the rental activity; and whose adjusted gross income, with certain adjustments, did not exceed $150,000. This is a generous exception and can come in handy for taxpayers wanting to offset their nonpassive income.
Although most rental activity falls under passive income, there is an exception to this rule: If your average rental period is less than 30 days, and you perform substantial services, the activity will be looked at as a business and will be considered active, rather than passive, income. Since this type of activity is not a passive activity, losses could be used to offset active income.
When reporting rental income, it is important to know that rental expenses such as cleaning, repairs, supplies, mortgage interest, and utilities can be deducted. How much of the expenses allowable as deductions is determined based on how often you rent the home versus your personal use of the home. If the vacation home is never used personally, then all expenses may be deducted. However, according to IRS rules, if you use the home both for rental and personal purposes, expenses must be allocated between both the rental, and the personal portion, of the tax form. Taxpayers may only offset their rental income with expenses that were generated during the rental period.
Rental activities can be a good source of extra income, but taxpayers should know how they will affect their taxes before engaging in these activities. Should you decide to rent your home, or a room within your home, keeping adequate records of rental periods and the expenses incurred is paramount to maximizing the benefits you should receive from reported activity.
If you have questions concerning the tax implications of your current or future rental activities, or would like to request a speaker on this topic for your organization or event, contact a related author below at (800) 270-9629.