The IRS has guidelines that define rental property. Two of the most common types of rental property include vacation homes and permanent rentals. Rental income is reported on your annual tax return, but money-saving deductions are associated with the expenses involved in renting a property.
What Is a Residential Rental Property?
A rental property is residential real estate that is available for usage in exchange for rent payments. This can include investment properties such as a single-family home, multifamily condominiums or even mobile homes. The IRS says in Publication 527 that the two most common types of rental activities are either long-term or short-term. The owner’s personal use of rental real estate is another major tax consideration.
Rental property owners are known as landlords. Often, a landlord is an individual or partnership but may also be a corporate entity, including exempt nonprofit organizations. Monthly rents and security deposits are paid directly to a landlord or a designated property manager in exchange for occupancy. An owner may also engage in active or passive participation in managing property.
The tax treatment of residential real estate investments can get a bit complicated as there are many considerations and operating expenses associated with rental property. Material participation, personal use and rental length will largely determine this treatment.
Differences Between Long- and Short-Term Rentals?
A long-term or permanent rental is never used as living quarters for the owner or any dependents he claims on his federal tax return. A permanent rental is a house, duplex or apartment complex serving full-time as a rental. This includes partial property rentals.
A partial property rental is one in which only a portion of the property is rented, and the other part serves as a primary residence for the owner. This is common with duplexes and apartment complexes with multiple rental units. This includes renting space, such as a bedroom or basement, within the owner’s primary dwelling.
The IRS defines another type of rental property as short-term or a vacation rental if rented for less than two weeks within a calendar year. A vacation home is considered a rental if it is rented out at any time during the course of the year. For most vacation homeowners, time spent at the vacation home is minimal compared to time spent at the primary home.
A homeowner can only deduct the portion of expenses associated with the vacation home that is incurred when renters live in the vacation home. Most tax specialists use prorated amounts to determine deductible rental expenses. If the vacation home is not rented out at any time during the year or the inhabitants are allowed to stay for free, the vacation home is not a rental property.
How Is Rental Income Treated for Taxes?
Rental income is usually regarded as passive income for tax purposes. An owner can deduct rental expenses, mortgage interest, property taxes and depreciation on income taxes but must report gross income. Fees paid to a property management company and landlord insurance premiums may also be deducted.
Typically, a property owner will file taxes using Schedule E, explains the IRS. However, with the rising popularity of short-term vacation rentals, Schedule C may be the more correct tax form in some circumstances.
For example, suppose you offer a short-term vacation rental where renters typically stay for less than seven days at a time. In that case, your participation is excepted as rental activity altogether, per IRS Publication 925. Another exception includes providing significant personal services to renters staying less than a month. In these scenarios, you would file a Schedule C for your taxes.
In the case of partial rentals, the tax treatment may include Schedule A. Tax deductions must exclude personal property where the owner resides and include all rental income. Roommates do not qualify as renters if they only assist with maintenance costs, such as mortgage payments.
Hashaw Elkins is a financial services and tax professional, as well as a project management consultant. She has led projects across multiple industries and sectors, ranging from the Fortune Global 500 to international nongovernmental organizations. Hashaw holds an MBA in Real Estate and an MSci in Project Management. She is further certified in organizational change management, diversity management, and cross-cultural mediation.