U.S. taxpayers are subject to taxes on their worldwide income, even income that is not reported on a tax slip (e.g. cash tips). Similarly, income from the rental of vacation homes may need to be reported as well. The tax rules may be further complicated in the case of non-resident U.S. vacation property owners. Therefore, proper planning is a must since not only can it help the individual save on taxes, but at times make tax-free income with the application of certain tax rules. We have helped several of our cross-border clients with U.S. property rental income reduce their taxes in certain situations.
Being informed about these tax laws may prove to be beneficial for taxpayers who own vacation properties, as they can discuss these laws with their tax advisors to use them as a part of their ‘tax plan’ for the current and subsequent tax years. In this article, AG Tax analysts have prepared a brief overview of the tax rules associated with vacation properties in the U.S.
U.S. Vacation Property Rules
The ’14-Day Vacation Property Rule’
If a personal residence or home is rented out for no more than 14 days in a calendar year by an individual owner, the income earned for this period is tax-free (there is no maximum limit), and the vacation property owner need not report it on their U.S. tax return. However, in this case the rental-related expenses cannot be claimed as deductions on the tax return, and proper records should be maintained for the 14 days (e.g. renter information, amounts received and expenses) in case it is determined that these rules did not apply or if the 14 day period was exceeded.
This exemption is often called the “Masters exemption” since homeowners in locations where certain popular events take place can earn significant amounts during these 14 days for which no U.S. federal income tax needs to be paid. For example, it is said that homeowners near Augusta National Golf Club, tend to earn as much as $25,000 (tax-free income) during the annual 4-day Masters Golf tournament. Opportunities also exist if one’s residence is close to popular events such as the Super Bowl or national political conventions.
Personal Use & Rental Use of Vacation Property
Almost every vacation property is used by the owner or the owner’s relatives during the year. If the property owner uses the vacation home for more than 14 days or 10% of the total days the house is rented at “fair rental price”, whichever is higher, it will be considered a “personal residence” and limitations may apply to the rental expenses you can deduct.
For example, if the owner or their family stays 30 days in the vacation home (personal use) while spending the other days of the year in their principal residence, then both properties would be considered personal residences unless the vacation property is rented out at fair rental price (i.e. rent paid for similar properties in that particular area) for at least 300 or more days during that calendar year. In other words the “personal use” portion must be 10% or less and no more than 14 days.
The IRS has a broad definition of ‘personal use’, and even days in which the property has been donated for a charity event or let out at a rent lower than the market standard to relatives, friends or others are all accounted as ‘personal use’ days of the vacation property.
If the vacation property is not used personally for more than 14 days during the tax year or 10% of the time the vacation home is rented (whichever is greater) the owner is consider to be running a rental vacation property business and qualifies to claim certain expenses incurred on the property as tax deductions.
Vacation property expenses must be divided between the rental use and the personal use based on the number of days used for each purpose. In most cases, the IRS will not allow you deduct your rental portion of expenses in excess of the gross rental income limitation (your gross rental income less the rental portion of mortgage interest, real estate taxes, and casualty losses, and rental expenses like realtors’ fees and advertising costs). However, some of these rental expenses may be carried forward to the next year, subject to the gross rental income limitation for that year.
Calculating The Number of ‘Personal Use Days’ and ‘Rental Use Days’
In order to calculate the number of personal use days and ‘number of rental use’ days of the vacation home, the following points should be kept in mind:
- Days the property is used by the owner or co-owners;
- Days the property is used by the owner’s or co-owners’ family members, except if it is rented out to a family member at a fair rental price;
- Days spent by a person with whom the owner has a sharing or exchange agreement (example: Person A allowing Person B to use their vacation home in Florida in exchange for use of Person B’s house in New York);
- Days spent by anyone at a rent lower than the fair rental price.
- Days the vacation home is rented out at a fair rental price.
Days spent fixing the vacation home, or maintaining the property are not counted as personal days while calculating the number of personal use days of the rental vacation property. The taxpayer must work on repairing a unit on a substantially full-time basis each day in order to exclude the day from being considered as a personal use day.
Tax Deductions & Filing for The Vacation Home
After calculating the number of days of personal use and rental use, if for the tax year the vacation home qualifies as a ‘personal residence’, real estate taxes and any mortgage interest payment may be claimed on Schedule A for tax purposes but no operating expenses incurred or depreciation can be claimed.
If the vacation home qualifies as ‘rental property’, then all the expenses incurred on operating the property (such as: advertising, realtors’ fee, etc.) or depreciation may be claimed on the income tax return. The individual would need to file a Schedule E to report the income and expenses from the rental vacation home.
If the vacation home is used for both personal and rental purpose, then the expenses need to be divided between the two based on the number of days used for each purpose. For example, if the total mortgage interest paid for the vacation home during the year is $8,000, and the property was used personally for a month, then the portion qualifying as rental expense would be approximately 11/12 of $8,000. Only the portion of the expenses qualifying as ‘rental use’ expenses should be deducted from the gross rental income, and the personal use portion of mortgage interest and real estate taxes may be claimed on Schedule A.
Rental property losses cannot be claimed but the unclaimed qualifying expenses may be carried forward to future tax years. (Read: How Qualifying as a Rental Real Estate Professional Can Help You Save on Taxes to know about claiming rental property losses).
NOTE: If the vacation home is rented out by the owner to their employer, any expense incurred do not qualify as rental business expenses, and cannot be claimed as a rental deduction but may be taken as an itemized deduction if for the benefit of the employer.
U.S. Rental Property & Non-Resident Owner
If the U.S. vacation home property owner is a non-resident (non-U.S.), then the tenant or U.S resident property manager acting as a U.S. withholding agent would withhold 30% of the gross rent paid as ‘withholding tax’ if the owner does not file a U.S. income tax return. In case of an non-resident individual, if the vacation home is rented out for 14 days or less, the non-resident individual does not need to file an annual U.S. income tax return; however the 30% withholding tax may still be required to be applied by the withholding agent under the U.S. withholding tax rules.
However, if the non-resident vacation home owner is running a rental business, and thereby has income effectively connected to a U.S. trade/business, he/she may file Form W-8 ECI, Certificate of Foreign Person’s Claim That Income Is Effectively Connected with the Conduct of a Trade or Business in the United States to avoid the U.S. withholding tax requirement. The property owner would then need to file an annual U.S. income tax return reporting the income earned and expenses incurred, like any regular U.S. business owner subject to loss limitation rules.
Taxpayers should be aware that this is just a small fragment of the actual law, and the rules may vary based on each taxpayer’s facts and circumstances, therefore taxpayers are advised to consult a tax professional for recommendations and advice based on their tax situation.
AG TAX LLP CAN HELP
If you have any tax-related queries, need assistance with tax planning or filing your tax returns please contact us. Our team comprises of highly experienced tax professionals with extensive knowledge of US and Canadian tax laws as well as cross-border compliance.
Furthermore, as a full service accounting firm, AG Tax assures complete assistance with even your most complex tax needs.
We can assist with:
- Canadian Personal and corporate tax returns
- Cross Border Taxation and Business Planning
- US Personal and Corporate Taxation
- Disclosure of Foreign Assets and other information filings
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- Estate Planning, Inheritance tax advice
To obtain a quote or to arrange for a consultation to discuss your tax related queries, please contact us at:
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