U.S. tax codes are notoriously complex, and when ventures like investment properties are added to the mix, everything becomes even more clouded. It is especially challenging if your investment property is in another state or country because laws and codes can vary drastically from one geographical location to another.
Fortunately, Unwind Luxury Vacations has a staff that includes former and current financial professionals who are adept at navigating tax minefields. While some owners embrace the challenge of deciphering tax laws, others take comfort in knowing the team at Unwind can collaborate with their CPA to make sure you are capturing the tax benefits that come with owning vacation rental property.
Whichever describes you, don’t let tax laws stop you from chasing your dream of owning a vacation rental property or expanding to own multiple properties. As always, we’re here to help.
There are a few main questions that are important to answer if you want to reduce your tax burden while staying compliant with tax laws on your investment property. Here are the primary things to know:
1. Determine if your property is an active or passive activity
Most vacation rental properties fall under the passive activity umbrella. According to the IRS Publication 925, “[t]here are two kinds of passive activities:
- Trade or business activities in which you don’t materially participate during the year.
- Rental activities, even if you do materially participate in them, unless you’re a real estate professional.” Note: this relates to long-term rentals and not vacation properties.
This can be confusing for some because nothing about owning an investment property is completely passive. Even if you have agreed to place the home under a property management firm such as Unwind, there are still profit-loss statements to review, maintenance decisions to make, site visits to take a few times per year, etc.
Your property is considered a trade or business if:
- Substantial services are rendered. Click here to see a list of substantial services.
- The average period of customer use of the property is 7 days or less.
- The rental is incidental to a non-rental activity.
In the event that your property meets the criteria for a trade or business, you will complete IRS Schedule C each year when filing taxes. If the property is owned by a pass-through entity (partnership or S Corporation), it will be reported on Schedule E as business income.
2. Know your tax deductions
Most vacation property owners want to keep their tax burden at a minimum in order to increase overall profit. To do so, it’s important to know what can and cannot be deducted from your vacation rental home taxes each year.
To qualify, your property needs to meet what is known as “the 14-day rule,” which contains two requirements:
- Your short term rental property needs to be available for rent for more than 14 days per year, regardless of the actual occupancy rate that it generates.
- You and your family cannot use the property for personal purposes for more than 14 days per year or 10% of the total number of rental days per year.
As long as the 14-day rule is met, you can qualify for available tax deductions on your vacation rental property. Here is a list of the deductions to consider for your home:
- Mortgage Interest
You can deduct all mortgage interest on rental properties as a business expense.
- Travel Expenses
When you travel overnight for business related to your vacation rental, you can deduct expenses such as airfare, accommodations, mileage, meals, and other travel expenses. This could include activities such as:- Traveling to your rental property to do repairs or maintenance
- Learning related to your rental, such as classes, seminars, conventions, or trade shows
- Meeting with business associates who work with you in your rental business
You can also deduct mileage for travel closer to home in order to visit your property or other related travel, such as going to a store to pick up supplies or equipment.
- Management Fees
If your property is managed by Unwind or another management firm, the management fees are deductible.
- Property Improvements
The list of potential improvements is long, and the ceiling for expenses is high (up to $1,050,000), so most improvement projects fall well within the boundary for tax deductions. This can include remodeling the kitchen, adding a bedroom, landscaping, making the home energy efficient, and more.
- Maintenance costs
Maintenance is separate from property improvements. Maintenance costs are more about the regular wear and tear on a home as opposed to concerted efforts to increase the home’s value. Vacation rental properties see a lot of wear and tear, especially if they’re frequently used as short-term rentals. So Section 179 of the tax code allows any repair or maintenance costs to be deductible expenses, with limitations.
Other deductions include: HOA fees, rental insurance costs, utility bills, marketing fees, and accounting fees.
3. The Value of Depreciation
Depreciation can equal tax savings if you’re able to write off the declining value of assets. If you’re just getting into the short-term rental market, for instance, you may be able to depreciate any new appliances, fixtures or furniture you buy to get the property ready to rent. A CPA can help you navigate the depreciation maze. They will walk you through what’s known as a Cost Segregation Study which aims to reclassify specific components of your property, transitioning them from a 39-year life (the standard depreciation life for a short-term rental property) to 5- 7, and 15-years. This applies to tangible personal property, land improvement property, and qualified improvement property.
5- and 15-year property components typically make up 20-30% of a property’s purchase price. As of 2024, we are in Year 2 of a 5-year phase out of certain depreciation codes. So by 2027 bonus depreciation disappears completely. However, the house passed a bill in January that reinstates the 100% bonus depreciation and that has now moved to the Senate for approval.
So, if you own a $1 million property and undergo a cost segregation study, approximately 15-20% of the property’s value could be re-segregated and fully depreciated.
If your losses are considered “non-passive,” they can be used to offset taxes on your W-2 income. If your losses are “passive,” they can only offset passive income, but can be carried forward to deduct in future years.
Let Unwind Help
You might be thinking that this simple 3-step guide to short-term rental taxes is not so simple after all. To be sure, there are many moving parts to consider when owning an investment vacation property.
But, Unwind is here to help with every step of the process. Our goal is to take the stress of property ownership out of the equation so that you can simply enjoy the benefits of your investment.
If you have questions about taxes or any other part of vacation property ownership, do not hesitate to reach out and ask.
Disclaimer: The above information has been prepared for informational purposes only and is not intended to provide – nor should it be relied on for – tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors prior to acting upon the information set forth in this article.
