Tax treatment of homes used for personal and rental purposes: a comprehensive guide and chart

There’s no going back to a world without property rental platforms like Airbnb and Vrbo. However, the complex topic of tax treatment for properties that are used for both personal and rental purposes, such as homes listed on short-term rental platforms, can be difficult to understand. This topic requires careful consideration and understanding, as it navigates the fine line between personal and business use of a property and often trips-up unwary taxpayers.

Understanding the dual-use property:

When a taxpayer decides to rent out their home, or a portion of it, while continuing to use it for personal purposes, it falls under the realm of dual-use or mixed-use property. This presents some unique tax considerations, as different rules apply depending on the number of days the property is used for personal versus rental purposes.

Key factors for determining tax treatment:

To determine the tax treatment of a dual-use property, you can use this flowchart to ascertain whether the property is primarily used for personal reasons or rental activities.

This flowchart helps determine if the property should be classified as a personal use home, a rental property or a combination of both.

Personal use home:

If the property is primarily used for personal purposes and rented out for fewer than 15 days annually, it falls into the category of a personal use home. In this case, rental income is generally tax-free and does not need to be reported on the taxpayer’s return. However, no rental expenses can be claimed against this income.

Rental property:

If the property is rented out for more than 15 days annually, and personal use is limited to 14 days or 10% of the total rental days (whichever is greater), it is considered a rental property. Rental income must be reported on Schedule E (Form 1040), Supplemental Income and Loss, of the taxpayer’s return. Additionally, various rental expenses such as advertising, property management fees and repairs can be deducted from the rental income.

Mixed-use property:

When personal use and rental use are both significant, creating a mixed-use property, tax professionals must allocate expenses between personal and rental portions based on the number of days of each use. Rental income and expenses should be reported on Schedule E, while personal expenses are typically non-deductible.

Common tax considerations:

Beyond the classification of the property, tax professionals should be aware of several common tax considerations for homes used for both personal and rental purposes:

Depreciation: If a property is used for rental purposes, depreciation can be claimed based on the rental portion of the property. However, the personal use portion is not depreciable.

Deductible expenses: It is crucial to educate clients about the expenses that can be claimed as deductions for rental properties, including repairs, maintenance, advertising, property management fees, utilities and mortgage interest (limited to the rental portion). This can be done during your planning sessions throughout the year.

Passive activity loss limitations: Tax professionals should also advise clients about the potential limitations on rental property losses, known as passive activity loss rules. These rules may restrict the amount of losses deductible against other sources of income, depending on your client’s level of participation in the rental activity.

Documentation and record-keeping: Accurate documentation is essential for homes used for personal and rental purposes. You should ask your clients to maintain records of rental income, expenses, and usage days to substantiate deductions claimed and support any potential audits.

Tax professionals play a vital role in guiding clients through the intricate tax treatment of homes used for both personal and rental purposes. By understanding the nuances of mixed-use properties, you can provide accurate and informed advice to your clients this tax season. If you’d like to learn more, there is an online training that will take a deep dive into the nuances of Schedules C and E, and more.