If you own a second home and it sits empty most of the year, it's probably occurred to you to rent it out and make some money from it. Income means tax issues, however, and the Internal Revenue Service's rules for rental properties are particularly complex. Many of them depend on how often you rent your property out and how often you're in residence yourself.
If you take on a tenant once a year for a limited period of time, such as because your second home is in New Orleans and you rent it out during the Mardi Gras, this can be a great tax advantage. Provided you rent the property for less than 14 days, the income is all yours. No matter how much it is, you don't have to share it with the IRS, and you don't have to declare it on your tax return. If you rent it out for more than 14 days, however, the pendulum swings. In this case, and if you personally use the property for 14 days or less, the IRS says it's an investment. You must report the rent as income.
If you don't rent out your home, your tax deductions for the property are limited to property taxes and mortgage interest. If you rent out your home consistently, however, you can deduct myriad expenses associated with maintaining it, including keeping an office in your primary home where you manage your rental business. You can use these deductions to offset your rental income, potentially bringing your tax liability for this money to zero. If the rental was for less than two weeks, however, you don't get this tax break. You can't take deductions for earning money you don't have to declare.
If your deductions and costs are greater than the rent you took in, you may have a passive loss. Depending on several factors, you may be able to use this loss to offset your income from other sources as well – a decided tax advantage. You must actively and personally manage the rental business of your second home to achieve this tax break, and this can take up a lot of your time. Otherwise, you can only claim deductions up to the amount of the rent you took in, although you can carry over any excess to future years. Unfortunately, you'll lose this advantage if you earn too much. Renting your second home probably won't be worth your while if your income exceeds $150,000 as of 2012. Above this threshold, you can't claim passive losses, such as those from real estate investments. This tax break also depends on how much time you personally spend in your second home. If it's more than 14 days or 10 percent of the time you rented it, you can't offset other income with your losses.
Calculating Personal Use
The IRS has some regulations regarding your tenants as well, and these can affect the pros and cons of renting your second home. If you rent to a family member, even if she pays you a fair market price for the property, this represents time that you’re living there yourself and it affects how you can treat your losses. An exception exists if your family member lives there full time, making the home her primary residence all year. In this case, the property is an investment, so you can use your losses against other income. If you charge an unrelated tenant less than fair market rent, tax law treats this situation as though the individual is related to you, even if she's not. These are personal days attributed to you when you're calculating what tax breaks renting your second home can offer you.
Beverly Bird has been writing professionally for over 30 years. She specializes in personal finance and w, bankruptcy, and she writes as the tax expert for The Balance.