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Renting Your Property? Consider These Implications
A few weeks ago, we received a call from a dentist who was considering purchasing a property in Florida. He wanted to use the property himself as well as use it as a rental, and wanted to know what pros and cons he should consider, especially the tax implications.
It’s a call we’re receiving quite frequently from dentists. With today’s depressed market values, the interest in purchasing real estate is certainly understandable, but it’s important to understand the tax implications of the purchase.
When considering real estate for rental income, it’s important to consider the economic area. Will you be able to rent the property? Is it still a hot vacation destination? And is it somewhere you would want to eventually retire yourself? And beyond the considerations for the property itself, how will you use it? The tax treatment of your rental can vary greatly depending on the length of time you rent it and the amount of personal use you receive from it.
If your property includes personal and rental use, known as mixed use, it falls into one of three property types, according to the Internal Revenue Service. The agency sets a threshold of 14 days of rental for determining which category your property fits.
Personal Residence, Very Limited Rental Use
If your home is used for personal purposes and rents for less than 15 days, you do not report rental income on it. (This usage is often used by “home makeover” shows, in which the production company rents the house for 14 days with the rental price being the upgrades made to the property. No income reported to the owner at the end of the rental period.)
Rules under personal residence with very limited rental use include: The income is not taxable but no Schedule E rental expenses are allowed. If the home is designated as the second residence, and the personal use exceeds the greater of
14 days or 10 percent of the number of rental days, interest is deductible on Schedule A. (If the property isn’t rented at all, it would just designated as the second residence.)
o As a second residence, the home cannot be a multi-million dollar property and the homeowner is limited to acquisition indebtedness and the limited equity indebtedness.
The Taxpayer may deduct real estate taxes on Schedule A.
Vacation Home with Rental and Personal Use
If the homeowner rents a home for more than 14 days and has personal use that is more than 14 days or 10 percent of rental days, tax treatment works like this:
Personal and rental use is prorated for determining the percentage of expenses allocated to each type of use.
Under vacation home rules, the IRS allows deduction of qualified second home interest and taxes 100 percent, divided between a portion on Schedule E and a portion on Schedule A.
The IRS also requires that other rental expenses be limited to the extent the homeowner receives income from the property, which is taken on Schedule E to the extent allowed.
If rental expenses exceed rental income, those expenses are suspended and carried forward to future years.
Rental Income with Very Limited Personal Use
Homeowners who rent their property and have less than 14 days of personal use or have personal use that does not exceed 10 percent of rental days, the income on the property would be reported on Schedule E.
Homeowners report prorated taxes by dividing them between Schedule E and Schedule A.
Unfortunately, the IRS considers the personal portion of interest to be “personal interest,” much like credit card interest, and is it not deductible.
The real estate investment game has changed dramatically based on market conditions, but it can still be a viable investment under the right circumstances. So when it comes to renting your personal property, the length of the rental and the amount of personal use you receive determines how your property income is treated by the IRS. Your tax professional can assist you in filing the appropriate return and determining the correct treatment for your situation.
How to Determine Tax Treatment of Property with Personal and Rental UsePersonal Residence Vacation Home Rental Property with
Personal UsePersonal use of the property for more than 14 days or 10% of rental time
Personal use of the property for more than 14 days or 10% of rental time
Personal use of the property does not exceed 14 days or 10% of rental time
Rented less than 15 days
Rented more than 15 days
Rented more than 15 daysPresented as rental property
Tax Treatment Steps Depending on Home or Rental UsePersonal Residence Vacation Home Rental Property with Personal
UseDo not report rental income Report rental income on
Schedule EReport rental income and expenses on Schedule E
Do not report rental expenses Prorate expenses between personal and rental use
Prorate expenses between personal and rental use
Report 100% interest on Schedule A if a qualified residence
Deduct personal portion of interest, taxes and casualty losses on Schedule A
Report personal taxes on Schedule A
Report 100% of real estate taxes Rental interest, taxes and Interest from personal use is not
on Schedule A casualty losses are not limited under the Internal Revenue Code
deductible
Other rental deductions are limited to remaining gross income from the property, subject to ordering rules
If presented as a rental, interest is deductible on Schedule A if the property is a qualified residence
Carryovers are allowed. Real estate taxes are deductible on Schedule
Alan Hill, CPA, serves as director of dental services. Working in Rea’s Mentor, Ohio office, he specializes small businesses and high net worth individuals. He can be reached at 440-266-0077 or [email protected]. Joseph Popp, JD, LM, is an attorney specializing in tax and estate planning working in Rea’s Columbus office. He can be reached at 614-889-8725 or [email protected].
