Many vacation homeowners are using their homes-away-from-home differently during the COVID-19 pandemic. As a result of usage changes, a vacation home may currently be treated differently for federal income tax purposes than it was in previous tax years.

How Vacation Home Usage Might Change?

Some usage changes relate to the property’s location and local COVID-related restrictions. Others are driven by the owner’s personal situation. Consider these examples:

• Aliah owns a primary residence in East Cambridge and a rental townhome in Sanibel Island, Florida. Last winter, she temporarily moved into her vacation home to escape COVID-related restrictions. She returned to Massachusetts in April and plans to rent out the townhome during the busy summer travel season. Normally, she spends less than two weeks per year in Florida.
• The Browns live in New York City, but they also own a vacation home in San Diego exclusively for their personal use. Due to safety concerns about air travel, they haven’t visited their vacation home since December 2019. In previous years, they spent a month each year at their California home. The couple recently contacted a management company for more information about renting out the property.
• Randall owns a restaurant in Newport that’s been subject to operating restrictions during the pandemic. For the first time, he’s decided to rent out his second home — a farmhouse in rural Vermont — to help supplement his lost income.
• The Rodriguez family lives in a single-family home near Providence. They also own a rental condo in Chicago. Due to canceled events and travel restrictions in the city of Chicago, the couple has experienced a significant decrease in demand from renters. Their niece is currently living in the property rent-free.
• Sam lives in Boston, and her employer recently adopted a permanent work-from-home policy. She also owns a vacation home in the Smoky Mountains. Sam has decided to sell her brownstone in Beacon Hill and permanently relocate to Tennessee to take advantage of the state’s lower taxes. But she’s debating on whether to move into her mountain cabin full-time or to sell it and find a larger home near Nashville.

Are you facing a similar situation? Here’s an overview of the federal tax rules related to vacation homes to help you make well-informed tax and investment decisions in today’s unprecedented conditions.

What Is a Vacation Home?

For federal tax purposes, a vacation home:

• Includes sleeping accommodations, a bathroom and a kitchen, and
• Is used for personal purposes.

Vacation homes may include single-family homes, townhouses, condominiums, yachts and houseboats.

Warning: If you’re spending significantly more time at your vacation home, it may affect your residency for tax purposes. Each state has different rules. Contact your tax advisor for more information.

Can You Rent Out Your Vacation Home?

Your vacation home can be rented to third parties, but the number of days it’s rented will affect the expenses you’re allowed to deduct.

Rules for vacation homes rented out for less than 15 days per year. These vacation homes are considered “pure” personal residences. This means you’re not required to report the rental income, and you can deduct mortgage interest and property taxes as if you didn’t rent out the home. (Remember, under current tax law, there are limits on itemized deductions for mortgage interest and state and local property taxes.) The downside is that you can’t deduct any expenses associated with renting the property, such as advertising, landscaping and cleaning costs.

Rules for vacation homes rented out for more than 14 days per year. In this situation, you can deduct the personal portion of mortgage interest and property taxes of a qualified vacation home as itemized deductions. In addition, you can deduct the rental portion of these expenses plus your other rental expenses and, depending on your income, you may be able to deduct up to $25,000 in losses each year.

What Is a Rental Property?

For federal tax purposes, your vacation home will be classified as a rental property, rather than a personal residence, if you or your immediate family members use the home for 14 days or less, or under 10% of the days you rent the property, whichever is greater.

If your property meets this definition, you can’t deduct the personal portion of mortgage interest as a rental expense, but you may report it as an itemized deduction. The same would be true for property taxes (within applicable limits). You’re required to report the rental income, but you can also deduct all rental expenses, including depreciation and other indirect expenses, subject to the complicated passive activity loss rules.

Tax Tip: If you make your vacation home your principal residence before you sell it, you might be able to exclude a portion of the sale price from tax.

Get It Right

If you’re using your vacation home differently during the pandemic, contact us to schedule a tax planning meeting. Our tax specialists can help identify potential tax pitfalls and allow owners to adjust their planned usage to minimize any adverse tax consequences and maximize potential tax breaks.