This past tax season we definitely noticed an uptick in the number of clients who rented out their homes through websites such as airbnb and VRBO. Moreover, we saw a larger jump in the number of clients asking us how they would be taxed if they were to rent out their home on a short-term basis a few times each year through one of these websites.
Believe it or not, if you rent the home for 14 days or less during a calendar year, the IRS allows 100% of the rental income received to be tax-free.
Here are the rules as spelled out in IRS Publication 527:
Used as a home but rented less than 15 days. If you use a dwelling unit as a home and you rent it less than 15 days during the year, its primary function is not considered to be rental and it should not be reported onSchedule E (Form 1040). You are not required to report the rental income and rental expenses from this activity.
Let’s say you can rent your home for $10k per week, and you rent the home out for only 2 weeks each year. In this example, you would put $20k of rental income into your pocket each year without owing a dime in federal income taxes. Now that’s great tax planning!
The IRS details the rules for homeowners who rent out their homes in Chapter 5 of IRS Publication 527, Residential Rental Property (Including Rental of Vacation Homes.)
The rules divide rental properties into three buckets based on the number of days rented versus the number of days used personally as follows:
- Rented 14 days or less – Income is tax-free and not even reportable on your tax return.
- Used personally for no more than the greater of 14 days or 10% of the days rented – Property is considered a rental property only, and all the expenses incurred during the year associated with that home offset any rental income received on a Schedule E. Losses may or may not be deductible based on your income.
- Rented more than 14 days and used personally more than the greater of 14 days or 10% of days rented – Considered a “mixed use” property. Here the rules get confusing, but essentially you first deduct 100% of any direct expenses including advertising, commissions, supplies, and any other expense incurred specifically in connection with the rental. All other expenses are prorated based on the days rented versus days used personally. Losses you can claim on this home are limited. IRS Publication 527 explains these rules in detail.
Reporting Tax-Free Income Reported to the IRS:
What should you do if you rent your home for 14 days or less during the calendar year and then receive a 1099-Misc during the following January reporting the rental income you received to the IRS? Even though this income is not taxable to you, the IRS is now expecting you to report the rental income as reported in Box 1 of the 1099-Misc somewhere on your personal tax return.
To keep this income tax-free, simply complete a Schedule E as follows:
- Write in the rental income reported to you on the Form 1099-Misc on line 3 of the Schedule E.
- On line 19 of the Schedule E, write “Rented Less Than 15 days”, and put the amount from line 3.
By following those two simple steps, the IRS will be happy since they will find the income reported to them on the 1099-Misc on your personal tax return. And you’ll be happy since you will not pay any federal income taxes on income that is not taxable to you.
In other words, the IRS won’t send you a notice incorrectly assessing taxes on the tax-free rental income reported to them on the 1099-Misc. And the rental income remains tax-free to you. You save the IRS a stamp while also saving yourself hundreds or thousands of dollars in federal income taxes.
When renting out your home for just a few weeks a year, please plan ahead to not rent out that home for more than 14 days. Once you hit 15 rental days, you’ll need to report that income on your tax return and also prorate your mortgage interest and real estate taxes between your rental activity and your personal use days; causing you to lose out on a portion of these valuable tax breaks.
Your tax return will also become much more complicated for the current year as well as future years due to how the mixed-use rental losses are carried over to subsequent years.
Stopping at 14 days, therefore, is probably more valuable than getting that 15th day of rental income.