Are you looking to earn some extra income by renting out your second home? If so, you need to be aware of the taxation rules that come with rental income. Failure to report and pay taxes on your rental income can lead to serious consequences, including penalties and legal issues.
In this article, we will discuss the taxation rules for rental income from a second residence, including overlooked tax deductions that could help you reduce your tax burden.
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How is the rental income from a second home taxed?
The Internal Revenue Code (IRC) requires that you report all rental income on Schedule E of your tax return, whether it’s from a primary residence or a second home. However, rental income from second home is only reported if it is for for more than 15 days in a year.
For rental of your second home for more than 15 days in a year, you must compute rental income by deducting expenses related to the rental property.These expense can be like property taxes, mortgage interest, insurance, repairs, maintenance, and utilities. For ready reference, Read the Section 280A(g) below:
280A (g) Special rule for certain rental use Notwithstanding any other provision of this section or section 183, if a dwelling unit is used during the taxable year by the taxpayer as a residence and such dwelling unit is actually rented for less than 15 days during the taxable year, then— (1) no deduction otherwise allowable under this chapter because of the rental use of such dwelling unit shall be allowed, and (2) the income derived from such use for the taxable year shall not be included in the gross income of such taxpayer under section 61.
However, if you use the second home for personal use , you cannot deduct expenses such as mortgage principal payments, personal utilities, and other personal expenses.
It’s important to note that the rental income you receive from your second home is subject to self-employment tax, which is currently at 15.3%. You must pay this tax on your rental income, along with your regular income tax.Have you read 25 Self Employed Deductions.
Overlooked tax deductions for second home rental income
As mentioned earlier, you can deduct expenses related to the rental property, which can help you reduce your tax burden. However, there are some overlooked tax deductions that could help you even more.
- First, you can deduct expenses related to traveling to and from your rental property, including airfare, hotel, and car rental.
- Second, you can deduct expenses related to advertising your rental property, such as website fees, signage, and classified ads.
- Third, you can deduct expenses related to professional services, such as property management fees, legal fees, and accounting fees.
- Fourth ,you can take advantage of the depreciation deduction. Depreciation is a tax deduction that allows you to deduct the cost of the property over a period of time. For rental properties, the depreciation period is 27.5 years. You can deduct a portion of the property’s value each year, which can significantly reduce your taxable rental income.
What are the limitations on deductions for vacation homes?
As per Section 280A of IRC , there are some limitations on deductions for vacation homes. If you rent out your second home for more than 15 days per year but also use it for personal purposes, you must allocate your expenses between rental use and personal use. You must then allocate expense proportionate to the period of rental and period of personal use.
For example, if you rent out your second home for 100 days per year and use it for personal purposes for 20 days, you can only deduct 80% of your expenses related to the property (100 days of rental use divided by 120 total days of use). If your total expenses are $10,000 and you received $8,000 in rental income, you can only deduct $8,000 in expenses, even if your total expenses were higher.
The same provision of law i.e Section 280A(g) provides that taxpayers can rent their dwelling unit to their business for up to 14 days per year, making the rental income tax-free and also write off the expense as home office deductions provided you maintain records and proof of conducting office business for 14 days in your home.
Use the Safe Harbor Rule for rental real estate
As per IRC Revenue Ruling 2019-07 ,the rental real estate activities can be treated as a trade or business for purposes of the IRC Section 199A qualified business income deduction.
To qualify for the safe harbor rule, you must meet certain requirements, including maintaining separate books and records and performing at least 250 hours of rental services per year. Rental services include tasks such as advertising, rent collection, maintenance, and repairs.
If you meet the requirements, you can deduct up to 20% of your rental income as a qualified business income deduction, subject to certain limitations. This can result in significant tax savings for rental property owners.
Can I deduct expenses related to personal use of my second home if I rent it out for more than 15 days per year?
No, you cannot deduct expenses related to personal use of the property. You can only deduct expenses related to rental use.
What happens if I fail to report my rental income on my tax return?
Failure to report rental income can lead to penalties and legal issues. You could be subject to fines, interest, and even criminal charges.
Can I deduct the full amount of expenses related to my rental property?
No, you can only deduct expenses related to rental use of the property, up to the amount of rental income you received.
How can I reduce my taxable rental income?
You can reduce your taxable rental income by taking advantage of overlooked tax deductions, such as depreciation, and by maintaining separate books and records to qualify for the safe harbor rule for rental real estate.
Do I need to pay self-employment tax on my rental income?
Yes, you must pay self-employment tax on your rental income, in addition to your regular income tax.
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