So you’ve decided to rent out all or part of your home or vacation property. While earning some extra money is nice, you’ll likely be complicating your tax situation by renting out your property.
Even so, the extra income can be worth the hassle. You’ll just need to be prepared with the proper information to make filing your tax return easier. What's even better? You may fall under an exception that means you won't have to report your rental income at all.
The Rental Income Exception
Believe it or not, the IRS allows you to rent out your home or vacation home completely tax-free in certain cases. However, you need to follow the rules. To qualify, you must rent out your home or vacation home for 14 days or less and use the home personally for 15 days or more during the tax year.
If you meet both of these requirements, any income you receive for those 14 or fewer rental days is 100 percent income tax-free on the federal level. You don’t even have to report it to the IRS when you file your tax return. But since you’re not paying taxes on the income, you also won’t get to deduct expenses like Airbnb booking fees.
That said, you can still deduct qualifying mortgage interest and property taxes on your primary or second home if you itemize your deductions.
The new tax law has reduced the total amount of mortgages allowed to $750,000, so those with expensive primary or secondary homes may face the mortgage interest deduction limit. Similarly, state and local taxes, including property taxes, are limited to $10,000 under the new tax law, which could limit your property tax deductions.
Make sure you keep track of which days you rent the property and which days you use it for personal purposes. This obviously won’t be a problem if you live in the home year-round. However, vacation homes aren’t always used as much as people would hope. If you don’t use the home personally for 15 days or more, you’ll lose the rental income exception.
What Happens If You Rent for More Than 14 Days Each Year?
If you rent your vacation home or a room in your primary residence for more than 14 days in a year, things get more complicated. You’ll now have to report income and expenses to the IRS. Unfortunately, this process isn’t necessarily easy for the average taxpayer.
You’ll have to keep detailed records and allocate your expenses based on rental time and your personal-use time. You’ll be able to deduct general expenses — such as utility bills, depreciation, and interest expense — only for the percentage of time the unit was rented. That said, you can fully deduct expenses that are 100 percent attributable to the rental.
These expenses may include Airbnb fees, advertising costs, or cleaning expenses that you pay after the unit is rented.
Here’s a quick example. Let’s say you rent out your vacation home for 180 days and you use your vacation home for 20 days. In total, it was used for 200 days. In most cases, 90 percent of the costs incurred by the property would be deductible, while 100 percent of the rental-specific costs would be deductible.
To make things even more complicated, you may not be able to claim a loss from your rental.
If you use your property more than 14 days or 10 percent of the number of days the property is rented, whichever is greater, you won’t be able to claim a loss from a rental, even if your expenses legitimately exceed your income. You can carry forward the loss to future years, though.
If you’re renting out a room in your home, you’ll also have to allocate your expenses based on a reasonable standard, such as square footage.
Let’s say you have a 2,000 square foot house and you rent out the 400 square foot master suite for the entire year. If you use the square footage allocation method, only 20 percent of the home expenses, such as mortgage interest and property taxes, would be deductible against the rental income.
Thankfully, if you rent out a property 100 percent of the time and don’t use it for personal use, things are much easier.
For example, Avery Carl, an affiliate broker at Bradford Real Estate, owns five properties that she rents out full-time on VRBO and Airbnb.
She deducts all of her legitimate business expenses, including, as she says, “cleaning in between guests, utilities, maintenance, gas, and the home office from which I manage my properties.”
Depending on your particular circumstances, Carl says you may end up having to report your income on Schedule C or Schedule E. You should consult a tax professional to help you determine which is best for you. Even then, Carl says, “Different CPAs will advise differently on the point of filing on Schedule E or Schedule C.”
Airbnb or VRBO may send you a 1099-K if you have over 200 reservations and earn more than $20,000 in a year. Even if you don’t receive a 1099-K, you’re still responsible for reporting 100 percent of the income you earn from your rentals unless you meet the 14-day tax-free exception. That means you’ll need to keep details on the income you earn, too.
You Might Have to Make Estimated Tax Payments
If you end up showing a profit for your rental activity, you might need to make estimated tax payments to avoid penalties. Estimated tax payments are made four times throughout the year using Tax Form 1040-ES.
If you’ll get a tax refund at the end of the year, you don’t have to bother with estimated tax payments. However, if you’ll owe $1,000 or more after accounting for any federal tax withheld from your paycheck, you may have to make estimated tax payments. There are other exceptions that can exempt you from making estimated tax payments, as well.
Consult an Expert About VRBO and Airbnb Taxes
Each person’s situation is unique, and the rules are extremely complex. The above are just some of the rules you’ll need to understand completely, and this is not meant to be relied on as tax advice.
Additionally, you may have to deal with state, city, and/or other local income taxes. Some localities will require you to pay short-term rental or hotel taxes, as well.
If you plan on renting all or part of your primary residence or vacation home through a company like Airbnb or VRBO, you should either fully educate yourself by learning the applicable tax law or hire an expert to guide you through the tax consequences. The money you pay for quality advice could be well worth it if it keeps you from paying interest and tax penalties.