Managing or owning a vacation rental can be a great side business and lucrative enterprise. But, like anything, there are tax guidelines that need to be kept in mind when navigating the vacation rental world. In this guide, we’ll do a crash course Tax Guide 101 For Vacation Rental so you can be prepared for how the IRS will treat your property and how you can get the most out of this business opportunity.
Vacation Rentals as Hotels
To begin with, it’s important to realize that if you own a cottage, cabin, condo, or beach home, the IRS may designate it a hotel. And a vacation-home hotel comes with its own tax requirements.
How do you know if your property is a vacation-home hotel? Look at how many days the average rental is. If the average rental time period is seven days or less, then it’s a vacation hotel.
This tax designation triggers the following:
- Tax law treats the property as a business, not a rental property.
- You must file a Schedule C where you will report all income and deductions
- You can deduct losses provided you “materially participate” in the activity. This means that as the operator, you are involved in the operation of a trade or business activity on a regular, continuous, and substantial basis.
To meet the criteria of material participation, according to the IRS, the taxpayer must have done the following:
- Worked for more than 500 hours in the business during the tax year; or
- The taxpayer did nearly all of the work in the activity including that of the individuals who didn’t own any interest in the property; or
- The taxpayer worked more than 100 hours in the activity and no one else worked more hours in relation to that property; or
- The taxpayer has materially participated in the activity in any 5 of the immediately preceding last 10 tax years.
- You still get to use your vacation hotel. This falls under the 14-Day or 10% Rule. According to the IRS rules, a vacation property can be rented out for up to two weeks (14 nights) each year without the need to report the rental income. That also means the owner can use their property for the greater of 14 days or 10% of the days rented and still qualify for vacation hotel status.
(Fun fact: Sometimes this is called The Master’s Exemption, named for the Master’s Golf Tournament when dozens of Augusta, Georgia, residents pull in “upwards of $25,000 in tax-free cash over the course of the four-day tournament by renting their homes to visiting spectators,” writes Forbes.)
To review: If you rent your home for less than 14 days, the property cannot be considered a vacation home.
On the flip side of the vacation hotel coin are the following tax situations:
- Back to that “material participation” concept. If you don’t qualify to have “materially participated” in your vacation hotel business, any losses on your vacation hotel aren’t deductible against your ordinary income. These losses are called passive-losses and are not deductible right away and get passed forward until you either: have rental income (or other passive income) you can deduct them against, or
- you dispose of your entire interest in the property.
- You could be subject to self-employment taxes.
- You let relatives stay in your vacation hotel, the broad definition of “personal-use” might murky the waters for your rental. Even if a family member is paying fair market rent, the IRS might consider their stay “personal-use” potentially and therefore change your vacation hotel status.
- If the IRS deems you did not materially participate and passive losses upset your loss deductions, you cannot switch your mortgage interest and property taxes from Schedule C’s “Profit or Loss From Business” to Schedule A to claim itemized deductions. In this situation, there are no take-backs.
How to navigate a vacation hotel audit
Anyone accepting rental income in any form should always be prepared to answer questions from the IRS and if it comes to an audit, here’s what you need to know.
- To defend your status as a vacation hotel, which, again, means your average rental is seven days or less, an owner needs to have all of their documentation in order. That includes rental receipts and length of stay information.
- If you want to qualify as having “materially participated”, you should be able to provide a record of the time you spent on the vacation hotel.
- Likewise, travel records related to the vacation hotel business should be kept and be in a presentable format.
- And you’d do yourself a favor by being well-versed in rental property tax rules well before you file. So avoid the pitfalls that others so often make and do your homework.
And when in doubt, seek out a tax expert with experience in the intricacies of rental property tax situations to help you properly manage your vacation hotel rental.