IRS view of Vacation Home Losses

10-22-2020Tax Information

Generally, if you rent out a vacation home while you not using it personally, you can deduct expenses to offset taxable income from the rental.  This includes mortgage interest, property taxes, repairs, utilities, insurance, etc. (Mortgage interest and property taxes are subject to additional rules for a qualified personal residence). 

You might even be able to deduct a loss on your income tax return in that year if your personal use of the vacation home does not exceed the greater of (a) 14 days or (b) 10% of the time the home is rented out.

Under the “passive activity loss” rules, you can only use losses from a rental activity to offset losses from other passive activities, with certain exceptions.

A loss from short-term rental of a vacation home may be allowed if the taxpayer “materially participates” in the rental activity.  Material participation requires involvement in the activity on a “regular, continuous, and substantial” basis.  The IRS regulations have created several tests for establishing material participation. For example, a taxpayer satisfies one test if he or she spends 500 hours a year on the activity.

One critical step to remember – keep contemporaneous records of all your activity.

In a recent ruling (Lucero, TC Memo 2020-136, 9/29/20), a taxpayer used a management company; but also did a fair amount of repair work on a short-term rental property (~270 hours in a year); but waited until the IRS examined the activity before creating a log of his activities (in order to substantiate claiming the loss).  In the view of the Court, the taxpayer’s estimates were exaggerated. In the end, the losses were denied.