Real Estate Investments

Here you will find a wealth of information dealing with real estate related income from investments, special treatment of the investments, and deductions associated with them. This is a broad and complex subject, so call us for more details about your specific situation and we’d be happy to assist you.

Deductions for Investors

Common Deductions

The costs related to your investments (with the exception of tax-exempt investments) are deductible as a miscellaneous itemized deduction (subject to the 2% of AGI limitation). They may seem trivial, but it can be worthwhile to keep track of these costs- they add up quickly- and they can reduce your taxable income. If the expenses happen to relate to both taxable and tax-free investments, you must prorate the expenses. Below are a few typical investment expenses you can deduct.

Investment Management Fees

Payments to a broker or an investment manager or advisor for management of your stocks and other investments is are deductible.

Investment Publications & Periodicals

Books and periodicals (not newspapers and similar publications) related to investing are deductible expenses.

Investment Travel

Trips to your broker or investment advisor, trips to look after investment property, and other such expenses related to your investments are deductible provided they are reasonable. Be prepared to prove your reasons for travel if the IRS makes an inquiry. Costs associated with investment-related meetings, seminars, and conventions are not deductible.

Meals & Entertainment

Half of the cost of your meals or entertaining costs in connection with your investments (such as taking your investment advisor to lunch to discuss your investments) are deductible. Again, these expenses must be reasonable.

Legal Fees

Payment for legal advice which is related to your investments deductible, but only to the extent that the advice pertained to your investments.

Professional Fees

Fees paid to your accountant for tax advice relating to investment transactions are deductible.

Safe Deposit Box Fees

Fees paid for your safe deposit box are deductible, but only to the extent that you store your investment documents.

IRA or Keogh Custodian Fees

These expenses are deductible, but only if you pay them directly to the custodian, not directly from your assets.

Dividend Reinvestment

Any service charges incurred as part of a dividend reinvestment plan are deductible.

Insurance Premiums

You may deduct the cost of insurance to protect your investments.

Home Computer Costs

You may deduct the expenses of your home computer, but only if you use the computer to manage your investment activities. You must depreciate the computer using the straight-line method and allocate between investment and personal use.

Software

Any money spent on software to manage your investments is deductible, however you must depreciate the software if it has a life of over one year and the cost is $100 or more.

Office Rent

You may deduct the expense of rented property which is used to manage your investments.

Collection/Broker Fees

Any fees paid to a broker, bank, trustee, or agent to collect taxable bond and note interest or dividends is deductible.

Investment Interest

You can only deduct the interest expense to the extent you have investment income. In a year you have capital gain, you may choose to treat any portion of that gain as investment income, but you must treat the elected capital gains as ordinary income.

Common Investment Errors

There are many ways that a little bit of knowledge can be risky when it comes to investments. Make sure you avoid these common mistakes!

– Any investment based on a cold call from an unknown broker.
– Assuming that all investment products sold by banks are insured.
– Assuming you can exchange fund shares without triggering a gain. These exchanges are taxable events, and any gain or loss must be accounted for annually.
– Buying last year’s hot investment; if the investment already hit it’s peak, your late investment may have nowhere to go but down.
– Following “hot” tips. If it sounds too good to be true, it probably is.
– Forgetting about the “wash sale” rules. Re-purchasing a stock or a mutual fund (including reinvested dividends) that you sold at a loss within thirty days of the previous sale results in the loss becoming nondeductible for tax purposes. See more on Wash Sales below.
– Equating “fixed income” with “fixed value.” In a time of rising interest rates, bond values can decrease.
– Equating high yields with high returns. Yield only deals with the income stream of an investment, not risk or volatility.
– Neglecting to review your investments on a regular basis.
– Purchasing mutual fund shares late in the year. Almost all mutual funds make annual capital gain allocations late in the year, generally December. Purchase right before these allocations could cause you to receive significant taxable income even though you’ve only owned the fund for a small portion of the year.
– Writing checks on mutual fund accounts. These checks can trigger a sale of fund shares that can be a taxable event.

Wash Sales Could Take You to the Tax Laundry

Tax law permits investors to offset capital gains with capital losses. If your losses for the year exceed the gains, you can deduct losses up to a maximum of $3,000 for the tax year. This is why it’s a good idea to review your securities portfolio at year’s end to search for stocks and other securities whose sales will result in a capital loss, thus minimizing gains or maximizing losses for the year.

If you aren’t careful, wash sale rules could ruin this strategy. Under these rules, a loss is disallowed if the security sold at a loss is repurchased within 30 days or if the investor buys the same security 30 days before the sale.

Mutual Fund Dividends

There are almost an infinite variety of mutual funds available: specializing in bonds, stocks, tax free instruments, foreign and domestic investments, growth stocks, income investments, specific industries and market segments, etc. Regardless of a specific fund’s investment strategy, most will generally pay some amount of dividends each year and those dividends will have a significant impact on your annual tax bite.

Ordinary Dividends – Generally, a dividend is a distribution paid by a corporation to its shareholders. Companies that are profitable will often distribute some of the corporation’s profits in the form of dividends. A mutual fund will collect dividends from its investments and in turn pass a pro-rata share of these dividends on to the investors in the fund. In addition, if the fund has short-term capital gains from the sale of the funds’ investments held for less than one year, each investor’s pro-rata share of these short-term capital gains is added to ordinary dividends. This is the reason some funds, which invest solely in tax-free instruments, will still distribute taxable dividends even though the underlying portfolio is tax-free investments.
Capital Gains Dividends – Represents the investor’s pro-rata share of long-term capital gains from the sale of the fund’s assets held over one year. These dividends receive the same special tax treatment as long-term capital gains and can be offset with any available capital losses from the sale of other capital assets. As with ordinary dividends, even though the fund may be invested in tax-free instruments, it may have long-term capital gains from the sale of some of its underlying portfolio.

Foreign Taxes Withheld – By tax treaty with most nations, taxes are withheld at a specific percentage rate on investment earnings paid from the foreign country. Mutual funds will report both the amount of foreign dividends and the amount of taxes withheld. These numbers are used to compute the foreign tax credit.

As an investor, you have the option to have your dividends paid to you in cash or you may choose to reinvest your dividends and buy more shares of the fund that paid the dividends. But keep in mind, because you have the option to take the dividends in cash, the tax consequences of either form of dividend payment are the same: You are taxed on all dividends received. The exceptions to this tax rule are dividends held in tax-deferred investments, such as an IRA or 401(k).

When you reinvest the dividends, you are essentially purchasing additional shares of the fund with money on which you have already paid taxes. Therefore, you are adding to your basis in the fund. It is important to keep track of the reinvested dividends, so that when you sell your fund shares you can account for the additional purchases when figuring your gain or loss. For mutual funds purchased after 1996, many funds will track your tax basis in the fund for you. You should check with each fund to determine if they provide these basis-tracking services. For more specific information pertaining to your specific circumstances, please contact this office.

Taxes on Dividends

Through 2012, dividends received by an individual shareholder from domestic corporations (and certain foreign corporations) are treated as net capital gain for purposes of applying the capital gain tax rates. This means dividends are taxed at 15% for taxpayers whose marginal rate is 25% or higher, and 0% for those in the 10% and 15% tax brackets. These rates are in effect through 2012. Capital losses cannot offset the dividend income for purpose of the tax computation. To qualify for the lower rate, the stock on which the dividends are paid must be held for at least 60 days during the 120-day period that begins 60 days before the “ex-dividend” date. Dividends on stock held in a retirement plan or traditional IRA will not benefit from the new lower rates; distributions from these plans continue to be taxed at ordinary income rates.

Investors with investments both in and out of tax qualified accounts should consider putting more of the interest-generating portion of their portfolios, which would be subject to tax at ordinary income rates in any event, into their 401(k)s and IRAs, and more heavily weight the investments intended to generate preferential capital gain and dividend income in their taxable accounts.

Depreciating Rental Property

Depreciation” is an accounting term for writing off the wear and tear on an asset that has a useful life of more than one year and costs over $100. Generally, rental real estate improvements must be depreciated over a period of 39 years. However, there are exceptions for residential rental real estate, which is depreciated over 27.5 years and most personal property such as furniture, equipment, etc., which is depreciable over 5 or 7 years. There are additional special rules applying to land rentals, leasehold improvements and restaurants. Please call this office for special situations.

Fine Tuning Capital Gains and Losses

Year-end has historically been a good time to plan tax savings by carefully structuring capital gains and losses. Conventional wisdom has always been to minimize gains by selling “losers” to offset gains from “winners,” and where possible, generate the maximum allowable $3,000.00 capital loss for the year.

Long-term capital losses offset long-term capital gains before they offset short-term capital gains. Similarly, short-term capital losses offset short-term capital gains before they offset long-term capital gains. (“Long-term” means that the stock or property has been held over one year.) Keep in mind that taxpayers may use up to $3,000.00 of total capital losses in excess of total capital gains as a deduction against ordinary income in computing adjusted gross income or AGI. Individuals are subject to federal income tax at a rate as high as 35% on short-term capital gains and ordinary income. But long-term capital gains are generally taxed at a maximum rate of 15%.

All of this means that having long-term capital losses offset long-term capital gains should be avoided where possible, since those losses will be more valuable if they are used to offset short-term capital gains or ordinary income. Avoiding this requires making sure that the long-term capital losses are not taken in the same year as the long-term capital gains. However, this is not just a tax issue; investment factors also need to be considered. It would not be wise to defer recognizing gain until the following year if there is too much risk that the property’s value will decline before it can be sold. Similarly, one wouldn’t want to risk increasing a loss on property that is expected to continue declining in value by deferring its sale until the following year.

To the extent that taking long-term capital losses in a different year than long-term capital gains is consistent with good investment planning, a taxpayer should take steps to prevent those losses from offsetting those gains.

However, historical tax-planning logic may not apply when the tax rates are expected to be higher in the next year or two:

• Increasing Capital Gains Rates – The special long-term capital gains rates that have been in effect since 2003 sunset (end) at the end of 2012 and return to the pre-2003 levels of 10% and 20%! These federal rates are currently 0% for taxpayers in the 15% and lower tax brackets and 15% for those in higher tax brackets. Individuals with large long-term capital gains in their investment portfolios might consider selling those holdings in 2011 or 2012 to take their gains at the lower tax rates. The good news here is that the wash sale rules do not apply to assets sold at a gain. So if you like a stock, you are free to buy it back right away. If your state doesn’t have a lower tax rate on capital gains, then the additional state tax you’d pay from selling profitable capital assets will need to be weighed against the federal tax you’d potentially save when deciding whether to make tax sales before year-end.
• Raising Marginal Tax Rates – At least through 2012, we are assured of retaining the lower individual tax rates which are currently 10, 15, 25, 28, 33 and 35 percent. These rates apply to “ordinary” income. Without Congressional intervention, the rates are scheduled to return to their original levels of 15, 28, 31, 36 and 39.6 percent, beginning in 2013.

With record government deficits, taxes have to go up—campaign promises notwithstanding—and we can expect that to happen in the near future. The only questions are when, how much, and for whom?

Conventional wisdom has always been to defer income, but with a potential for increased taxes it may be appropriate to consider accelerating income to take advantage of the current lower tax rates.

It may be in your best interest to review you current year tax strategy with an eye to the future to maximize your benefits from gains or losses associated with capital assets. Please call this office for assistance.

First, Last and Security Deposits

Generally, landlords require a new tenant to pay the first and last month’s rent in advance along with a security deposit. A frequent question is whether to treat these payments as current-year income or income to a future year. The IRS says that advance rent payments are income in the year received. However, security deposits you plan to return to your tenant at the end of the lease are not income. But if you keep part or all of the security deposit during any year because your tenant does not live up to the terms of the lease, then the amount kept is income for that year.

Operating Expenses

For tax purposes, you will figure your profit or loss each year from operating the rental property. Generally, you can virtually deduct all expenses incurred to operate the rental.
The following is a list of potential operating expenses that are deductible:

* Advertising
* Bank charges – if account is separate
* Cleaning/Maintenance
* Depreciation allowance
* Homeowners or association dues
* Insurance – fire, casualty and liability
* Mortgage interest – purchase/improvement debt
* Property management fees
* Property taxes
* Rental commissions
* Repairs – not the same as improvements
* Services – pest control, pool and yard care, etc.
* Tax return preparation fees
* Transportation – local expenses
* Utilities – electricity, gas, water, etc.

NOTE: If any individual or company providing these services is paid $600 or more during the year, you are required to issue them a 1099MISC.

Outright Sale

When a rental property is sold outright, the entire gain will be taxable in the year of sale. Let’s assume (without considering property improvements or buying or selling costs) that you purchase a rental for $50,000 and then several years later sell it for $300,000. Over the period of time that it was a rental, you took $10,000 in depreciation deductions. Your tax basis in the property at the time of sale would be $40,000 (your cost of $50,000 less the $10,000 taken in depreciation). Thus, your gain would be $260,000 (the sales price of $300,000 less your tax basis of $40,000). The recaptured depreciation of $10,000 can be taxed as high as 25%, depending on your tax bracket and the balance of the gain ($220,000) is taxed at a maximum of 15%.

Real Estate Professional

If you qualify as a “real estate professional” (which requires the performance of substantial services in real property trades or businesses), your rental real estate activities are not automatically treated as passive, and so losses from those activities can be deducted against earned income, interest, dividends, etc., if you materially participate in the activities. Please call this office for additional details associated with this limited exception.

Rental Real Estate and Taxes

A popular form of long-term investment is real estate rentals. Rentals can fall into several varieties, of which real estate rentals is the most common. This material will explain some of the tax ramifications of renting real estate, both residential and commercial. Specifically excluded from this discussion are transient rentals, where the tenants rent for an average of seven days or less, such as motels and equipment (machinery) rentals. Both are considered self-employment businesses for tax purposes and thus subject to self-employment taxes.

One of the biggest benefits of owning rental property is that the tenants, over time, buy the property for you. In addition, if structured properly, the allowable depreciation deduction will shelter the rental income. Another historical benefit of real estate rentals is capital appreciation. Before acquiring a rental property, there are a number of things to consider, which include the following:

After-tax cash flow,
Potential for long- or short-term appreciation,
Property condition (with an eye on when you might get stuck with a large repair bill),
Debt reduction,
Type of tenants,
Potential for rent increases or re-zoning, and
Whether there is community rent control, etc.

Although most of the considerations are subjective, the after-tax cash flow can be estimated fairly easily.

For tax purposes, you will figure your profit or loss each year from operating the rental property. Generally, you can virtually deduct all expenses incurred to operate the rental. Browse through our list of potential operating expenses that are deductible. In addition, you will need to keep track of repairs and improvements and know how to distinguish between the two.

Rental real estate income is business income but is not subject to Social Security taxes. Real estate rentals are also considered passive activities. Generally, passive activity losses are only deductible to the extent of passive activity income. However, there are two exceptions to that rule: (1) where there is active participation, and (2) real estate professional exception. Any losses not allowed under these two exceptions are not lost but suspended, and carried forward indefinitely to tax years in which your passive activities generate enough income to absorb the losses. To the extent your passive losses from an activity aren`t used up in this fashion, you will be allowed to use those losses in the tax year in which you dispose of your entire interest in the passive activity in a fully taxable transaction.

Renting Part of Property

If you rent part of your property, such as a room or a portion of the house, you must divide certain expenses between the part of the property used for rental purposes and the part of the property used for personal purposes, as though you actually had two separate pieces of property. You can deduct the expenses related to the part of the property used for rental purposes, such as home mortgage interest and real estate taxes, as rental expenses. You can also deduct as a rental expense a part of other expenses that normally are nondeductible personal expenses, such as utilities and home repairs (such as painting the outside of your house). You do not have to divide the expenses that belong only to the rental part of your property. For example, if you paint the room that you rent or pay premiums for liability insurance in connection with renting a room in your home, the entire cost is a rental expense. If you install a second phone line strictly for your tenant’s use, all of the cost of the second line is deductible as a rental expense. You can also deduct depreciation on the part of the property used for rental purposes, as well as on the furniture and equipment used for that purpose.

Generally, the most frequently-used methods of allocating expenses between personal use and rental use are: (1) based on the number of rooms in the home, and (2) based on the square footage of the home. You can use any reasonable method for dividing the expense. It may be reasonable to divide the cost of some items (for example, water) based on the number of people using them.

Repairs vs. Improvements

When you figure your profit or loss from operating the rental property each year, you can deduct the cost of repairs to the rental property. However, any improvements that were made must be depreciated over the improvement’s useful life. How do you distinguish a repair from an improvement?

Repairs – A repair keeps your property in good operating condition and does not materially add to the value of your property or substantially prolong its life. Repainting your property inside or out, fixing gutters or floors, fixing leaks, and replacing broken windows are examples of repairs. However, if the repairs are part of an extensive remodeling or restoration of your property, the whole cost is an improvement.

Improvements – An improvement will add to the value of the property, prolong its useful life, or adapt it to new uses. If you make an improvement to a property, the cost of the improvement must be capitalized. The capitalized cost can generally be depreciated as if the improvement were separate property.

Separating Improvements from Land

Not all of the cost of acquiring real estate is depreciable. Specifically, the cost of the land is not depreciable and must be separated from the improvements. Thus, you should identify and document at the time that you acquire real estate, the part of your overall acquisition cost allocable to improvements. One way to accomplish this is to retain a qualified real estate appraiser to make an allocation between land and improvements, or if the real property tax bill for the property includes an allocation, and most do, use that allocation. When using the property tax, the total of the allocation between the land and improvements probably will not equal the actual purchase price. In that case, simply allocate the land and improvements in the same proportion as the property tax bill. Any improvements made after the original purchase should be accounted for and depreciated separately, since there is no land allocation associated with the improvement.

Special Considerations

Active Participation
If you “actively participate” in the residential rental activity, you may be able to deduct a loss of up to $25,000 ($12,500 if you’re married, file separately, and live apart from your spouse for the entire year—but if you’re married, file separately and don’t live apart from your spouse for the entire year, you’re not eligible for this break at all) against ordinary (nonpassive) income such as your wages or investment income. You actively participate in the rental activity if you make key management decisions such as whom to rent to, the rental terms, approving capital expenditures, etc. You also can show active participation if you arrange for others to provide services. Active participation does not require regular, continuous and substantial involvement with the property. But in order to satisfy the active participation test, you (together with your spouse) must own at least 10% of the rental property. Ownership as a limited partner does not count. If your adjusted gross income (AGI) is above $100,000, the $25,000 allowance amount is reduced by one-half the excess over $100,000. (If you’re married, file separately and are eligible for the break, the $12,500 allowance amount is reduced by one-half the excess over $50,000.) Under this rule, if the AGI is $150,000 or more ($75,000 or more for eligible married taxpayers who file separately), the allowance is reduced to zero. For these purposes, AGI is modified to some extent, e.g., you ignore taxable Social Security income and the Individual Retirement Account (IRA) deduction.

Tax-Deferred Exchange

A tax-deferred exchange (otherwise known as a “1031 exchange” referring to the tax code section pertaining to exchanges of property or “tax-free exchange” and a misleading title since the tax is actually deferred and not free”) can be used as a means of avoiding immediate taxation on the gain from a rental property by deferring the gain into a replacement property.
Reasons to Exchange: Structuring a transaction so that it meets the requirements of Section 1031 can offer many benefits to a taxpayer, including:

(1) A taxpayer can acquire a property without the availability of a great deal of cash.
(2) A tax-free exchange allows greater creativity to a taxpayer in converting a business property into personal-use property. The exchange allows a taxpayer to acquire a property suitable to personal use prior to conversion.
(3) Exchanges put off the payment of tax on a transaction. The effect is like getting an interest-free loan from the government.
(4) The problem of “excess of mortgage over basis” is avoided. When a mortgage exceeds basis, the excess is ordinary income in the year of sale when the installment method is used. This is not true with an exchange.

Business or Investment Use Requirement – To qualify for a Sec 1031 exchange, the properties exchanged must both be held for business or investment use.
Like-Kind Requirement – The properties exchanged must be like-kind (similar in nature, but not necessarily of the same quality). Real estate must be exchanged for real estate (improved or unimproved qualifies).

Caution: Sometimes real estate is held in a partnership or other entity. Generally, an entity ownership does not qualify as like-kind. Although, tenant-in-common interests (sometimes referred to as TICS), if structured properly, can. Please contact this office for details.

Property Acquired with Intent to Exchange – If a taxpayer acquires (or constructs) property solely for the purpose of exchanging it for like-kind property, the IRS says that the taxpayer doesn’t hold the property for productive use in a trade or business or for investment, and as to the taxpayer, the exchange doesn’t qualify for non-recognition treatment under Code Sec. 1031.

Simultaneous or Delayed – The exchange can be simultaneous or delayed. If delayed, the property received in the exchange must be identified within 45 days after the property given is transferred.

No matter how many properties are given up in an exchange, a taxpayer is allowed to designate a maximum of either:

(a) Three replacement properties regardless of FMV, or
(b) Any number of properties, as long as the total FMV isn’t more than 200% of the total FMV of all properties given up.

If a taxpayer identifies replacement properties over these limits, he/she is treated as if none were identified. A taxpayer can, however, revoke an identification at any time before the end of the 45-day time period.

The receipt of the new property must be completed before the EARLIER of:

(1) 180 days after the transfer of the property given, OR
(2) The due date (including extensions) of the return for the year in which the property given was transferred.

Qualified Intermediary – Generally, to qualify for a delayed Sec 1031 exchange, a qualified intermediary is engaged to hold the funds from the sale until the replacement purchase is made. It is important to understand that the taxpayer cannot take possession of the proceeds from the sale and then buy another property. If that happens, the event does not qualify for exchange and is immediately taxable.

Reverse Exchanges – It is possible to structure a reverse exchange that complies with the Section 1031 delayed exchange requirements. However, it requires that the replacement property be purchased first, by the intermediary, without the benefits of the proceeds from the property given up in the exchange. Thus, only taxpayers with the cash financial resources can accomplish reverse exchanges.
Tax-deferred exchanges can be very tricky and should not be entered into without first analyzing the tax aspects. Exchanges are actually equity exchanges, and if a taxpayer reduces their equity position (takes out cash or boot in the exchange), then the gain might not be deferred and the expense of structuring an exchange wasted. As a rule of thumb, if a taxpayer moves up in property value and up in equity in the property, there is a taxable event. Please call this office before initiating the transaction.

Tax Strategies in a Down Market

Sell Loser Stocks To Offset Gains – With the roller coaster ride the stock market often provides, you may have a mix of winners and losers in your investment portfolio. If you have a net gain for the year, you should consider selling enough of the losers to offset the gain and produce a net loss of at least $3,000. This will erase your tax liability from the gains and allow you to deduct $3,000 against ordinary income. Don’t worry about having exactly a $3,000 net loss; any unused losses will carry over to future years. This strategy also works for capital gain dividends from mutual funds. Be careful not to repurchase any of the stocks you sold at a loss for 31 days. If you do, the loss will not be allowed because of the “wash sale” rules.

Check Your Mutual Fund’s Capital Gain Distribution Dates – Don’t end the year to find your mutual fund is down, but has still distributed large capital gain dividends that you must pay taxes on. If you sell before the fund’s distribution date, you can avoid paying tax on those capital gain distributions. If you plan on reacquiring the same fund, you will need to wait 31 days to avoid the wash sale rules. However, you can buy a similar fund of another fund family immediately.

Convert Your Traditional IRA To A Roth IRA – When you convert a Traditional IRA to a Roth IRA, you generally pay taxes on the value of the Traditional IRA converted. Therefore, the lower the value, the less it will cost to convert it to a Roth IRA. If you have one or more IRA accounts invested in stocks or mutual funds that have declined in value, this might be a good time to convert it to a Roth IRA.

It generally makes sense to convert to a Roth if you have many years to go before you plan on withdrawing your funds. Another reason to convert to a Roth is to pass on money to your heirs. Unlike a Regular IRA, there are no mandatory withdrawals while you are alive (so there would be more money left in the Roth account to pass to your heirs than if you’d kept the Traditional IRA), and your heirs will not be liable for income taxes.

To convert, you must pay taxes on contributions and accumulated earnings in the same year. However, for 2010 conversions, a special rule permits the taxes to be paid in 2010 or deferred until 2011 and 2012. Prior to 2010, conversions were not allowed if your income in the conversion year was over $100,000; this cap was removed as of 2010, so more taxpayers are eligible to make conversions.

The conversion tax can be a very hefty bill, so if you need to take money out of your IRA to pay the taxes and you are under age 59 ½, you will be subject to a penalty on the amount withdrawn to pay the taxes.

It is recommended to call this office before making a conversion to avoid any unpleasant surprises.

Vacation Home Rental

There are special tax consequences when you rent out your vacation home for part of the year. The tax treatment depends on how many days it is rented and your level of personal use. Personal use includes vacation use by your relatives (even if you charge them market rate rent) and use by non-relatives if a market rate rent is not charged.

Rented less than 15 days – If you rent the property out for less than 15 days during the year, the property is not treated as a rental. Any rents received are not includable in income no matter how substantial the income might be, and no deductions are allowed other than property taxes and mortgage interest deducted as an itemized deduction subject to the normal limitations. No other operating costs and no depreciation are deductible.

Rented 15 days or more AND the taxpayer’s personal use is less than 15 days or less than 10% of the rental days – Allocate expenses according to personal vs. rental days. No further limitation is necessary (except the usual “not-for-profit” rules must be considered). A loss can be claimed.

Taxpayer use is 15 days or more and over 10% of the rental days – First allocate expenses by personal vs. rental days, as in the previous paragraph. Deduct allocable taxes and interest first, then maintenance and other cash expenses and then depreciation until the net is ZERO. A loss cannot be claimed.

When determining the personal-use days, do not include days where you are there to perform repairs or to fix up the property.

This is a generalized overview of the “vacation home rental rules.” There are other subtle points in the law related to vacation home rentals. Please contact this office before drawing any final conclusions.

Taxation Solutions, Inc.

12250 Queenston Blvd Suite H, Houston, TX 77095