Rental Income and Expenses
The net income from rental property is taxable. In most cases, rental income is reported with the related expenses on Part I of Schedule E. If services are provided to the tenant beyond those customarily provided, such as cleaning and maid services, the income is reported on Schedule C and is subject to the self-employment tax. Expenditures deductible as rental expenses include real estate taxes, mortgage interest, insurance, commissions, repairs, and depreciation.
If the rental property is a “vacation home,” the taxability of rental income and the deductibility of expenses depends on whether the property is classified as a primarily personal-use, primarily rental-use propertyprimarily rental-use propertyResidence rented 15 or more days and used for personal purposes 14 days or fewer (or 10% of the days rented whichever is greater)., or rental/personal propertyrental/personal propertyResidence rented 15 or more days and is used for personal purposes for more than 14 days (or 10% of the days rented whichever is greater)..
Example
Mike owns a condo in Truckee, California, which he rents for three months during the year and used by Mike for one month. If there were no vacation home limitations, Mike could deduct eleven months’ worth of depreciation, maintenance, and other costs associated with the property. The resulting loss could then be deducted against Mike’s other taxable income.
To prevent taxpayers from claiming a deduction for expenses effectively personal in nature (associated with a personal residence), the tax law limits the deductions a taxpayer can claim for expenses associated with a vacation home. Deductions attributable to vacation homes used primarily as personal residences are limited to the income generated from the rental of the property. In general, only profit or break-even (no loss) tax situations are allowed on the rental of vacation homes.
Primarily personal-use propertyprimarily personal-use propertyResidence that is rented for fewer than 15 days. is a residence that is rented for fewer than 15 days during the year. Essentially, the rental period is disregarded and it is treated as a personal residence for tax purposes. The rental income is not taxable and the mortgage interest and real estate taxes may be allowed as itemized deductions. Other expenses, such as utilities and maintenance, are considered nondeductible personal expenses.
Example
Nancy owns a home on Lake Tahoe. During the year she rented the home for $4,800 for two weeks, lived in the home for three months and left the home vacant during the remainder of the year. The expenses for the lake home included $5,000 in mortgage interest, $4,600 in property taxes, and $3,300 in utilities and maintenance, and $6,000 in depreciation. Since the lake home was rented for fewer than fifteen days, Nancy would not report the $4,800 of income and would deduct only the interest and taxes as itemized deductions on Schedule A. The other expenses are nondeductible personal expenses.
Primarily rental-use property is when the residence is rented for 15 days or more and is used for personal purposes for not more than 14 days or 10% of the days rented, whichever is greater. Essentially, the residence is treated as rental property. The expenses must then be allocated between the personal and rental days and if the rental expenses exceed the rental income, the resulting loss would be deducted against other income, subject to the passive loss rules.
Example
Assume the same facts for Nancy’s Lake Tahoe home except that the $4,800 rental income is for 20 days, and Nancy uses the lake home for only 10 days during the year. Since the lake home is now rented for 15 days or more and Nancy’s use of the home is not more than 14 days (or 10% of the days rented, if greater), the property is treated as primarily rental property. Expenses are allocated by using the number of days of rental or personal use compared to the total number of days of use. Nancy’s personal use percentage is 33.33% (10 days/30 days) and the rental portion is 66.67% (20 days/30 days). For tax purposes the rental income (loss) is calculated as follows:
| Rental (66.67%) | Personal (33.33%) | |
|---|---|---|
| Income | $4,800 | 0 |
| Interest and Taxes | (6,400) | (3,200) |
| Utilities and Maintenance | (2,200) | (1,100) |
| Depreciation | (4,000) | (2,000) |
| Rental Loss | $(7,800) |
Property that is rental/personal is when the residence is rented for 15 days or more and is used for personal purposes for more than 14 days or 10% of the days rented, whichever is greater. In this situation, rental expenses are allowed only to the extent of rental income. Allocable rental expenses are deducted in three separate steps: first, the interest and taxes are deducted; second, utilities and maintenance expenses are deducted; and third, depreciation expense is deducted. For utilities, maintenance, and depreciation expenses to be deductible, there must be positive income following the deduction of items in the preceding step(s). In addition, the expenses, other than interest and taxes, are only deductible to the extent of that positive income. Expenses are allocated between the rental and personal days before the limits are applied. The IRS requires that the allocation be on the basis of the total days of rental use or personal use compared to the total days of use.
Example
Assume Nancy rents the Lake Tahoe home for $4,800 for 20 days and uses it for personal purposes for 60 days. Also assume that utilities and maintenance expenses are $4,300 and other expenses are the same. Since the lake home is rented for 15 days or more and Nancy used the home for personal purposes for more than 14 days (or 10% of the days rented, if greater), the property is subject to the rental/personal property category limitations. Nancy’s personal use percentage is 75% (60 days/80 days) and the rental portion is 25% (20 days/80 days). The IRS requires that the rental income or loss be calculated as follows:
| Rental Income Statement | ||
|---|---|---|
| Rental (25%) | Personal (75%) | |
| Income | $4,800 | 0 |
| Interest and Taxes | (2,400) | (7,200) |
| Subtotal | $2,400 | |
| Utilities and Maintenance | (1,075) | (3,225) |
| Subtotal | $1,325 | |
| Depreciation ($1,500, limited to $1,325) | (1,325) | (4,675) |
| Rental Loss | $0 | |
The interest and taxes allocable to Nancy’s personal use of the property in the last two examples are deductible as itemized deductions on Schedule A. The personal portion of the utilities, maintenance, and depreciation is a nondeductible personal expense.
Go to Publication 17 and read chapter 9: Rental Income and Expenses.
Questions and Problems
Ray owns a second home in Ft. Bragg, California. During the year he rented the house for $3,000 for 30 days and used the house for 15 days. The house was vacant during the remainder of the year. The house expenses included $5,000 in mortgage interest, $800 in property taxes, $900 for utilities and maintenance, and $3,500 of depreciation. What is Ray’s deductible rental loss, before considering the passive loss limitations?
$0
$3,400
$3,800
$7,200
$10,200
Which of the following is not correct about the rental of real estate?
A vacation home is a home that is rented for 15 days or more and is used by the taxpayer for personal use for more than the greater of 14 days or 10% of the days it is rented for fair value during the year
If a vacation home is used by the taxpayer’s son for a discounted rental price, those rental days are considered personal use days
Depreciation and maintenance expenses for an apartment complex are deductible
Repairs on rental property are deductible by the taxpayer
All of the above are correct
Stan buys a rental house on August 14 for $209,000. Of this amount, $140,000 is considered to be allocable to the cost of the home, with the remainder allocable to the cost of the land. What is Stan’s maximum depreciation deduction for the year using MACRS?
$941
$1,910
$2,851
$5,090
Some other amount
Tatyana owns a house that she rents to college students. She receives $900 per month rent and incurs the following expenses during the year: Real estate taxes $1,750; Mortgage interest $1,600; Insurance $580; Repairs $560. Tatyana bought the house in 1980 for $36,000, excluding land costs, and depreciates it on a straight-line basis with no salvage value and a useful life of 30 years. Calculate Tatyana’s net rental income for the year, assuming the house was rented for a full twelve months. $__________
Trisha rents her vacation home for six months and lives in it for six months during the year. Her gross rental income during the year is $5,000. Total real estate taxes for the home are $1,100, and interest on the home mortgage is $3,000. Annual utilities and maintenance expenses total $1,600, and depreciation expense is $4,800. Calculate Trisha’s taxable net income from the vacation home for this tax. $__________
