Owning a vacation home creates new tax situations for most people. In the case of a co-owned vacation home, the same principles apply except in a few situations. You can effectively learn how to manage your taxes in a co-owned vacation home by following these principles.
One of the first decisions a group must agree upon is the use of the property. Will it be primarily an investment, with the maximization of rental income being paramount? Will it be reserved only for the enjoyment of the owners and their friends and family? Or will it be some hybrid of owner’s use and rentals? This decision will directly affect the tax rules the group must follow.
Primarily Rental
If the owners use the property for less than 14 days a year (excluding days primarily used repairing and maintaining the property), expenses can be deducted from the rental income.
These expenses include four categories:
- Mortgage interest, real estate taxes and casualty losses
- Expenses related to rental of the property
- Expenses related to operating and maintaining the property
- Depreciation and basis adjustment of the property
Primarily Owners’ Use
While owners won’t be able to deduct rental expenses, they will be able to claim the usual homeowner’s deduction for mortgage interest, real estate taxes and casualty losses. The owners can rent the home for up to 14 days without paying tax on the earned income. This can be lucrative if there is a special event that drives rental prices through the roof, like an annual music festival or professional golf tournament.
Mixed Use
If the property is rented more than 14 days a year (or 10% of the number of days which the unit was rented at FMV), the owners can still deduct expenses from the rental income, but expenses cannot exceed income and they must be prorated. The proration rate is determined by dividing the number of days the property is rented at fair market value by the total number of days it is used for personal use (by any of the owners or their friends and family) combined with rental days. Depreciation and basis adjustments are prorated according to the same formula.
Important Considerations
With the complexity of these tax rules, it is important to hire a tax professional to help the group abide by the IRS’s rules. Also, precise record keeping is needed to account for each day of use for the property and whether it is personal use, maintenance/repair use or fair market rental use.
*Plum CoOwnership, Inc. is not a tax expert, please consult with an accountant or tax attorney for expert advice.
