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Tom Kelly
Tom Kelly
The Real Estate Adviser

May 22, 1998

Should you rent the cabin?

By TOM KELLY
The Real Estate Advisor

We have so many siblings -- there are seven adult Kelly children and as many in my wife's family -- that we are constantly invited to weddings, graduations, school plays and too many athletic events with bad bleachers. But the idea of an actual vacation reunion -- without any other related event -- has not surfaced in a few years. That's probably a result of previous experiences. We always seem to put in weeks of preparation for one week of rain.

I thought about those times this week when a downtown resident wrote to ask about the tax ramifications of renting her high-rise condo for three weeks while she took her family to Idaho for a family reunion.

She is not alone in asking this tax question. If you are headed out of state to a family reunion with uncles and aunts you never knew existed and are feeling anxiety pains because the family summer getaway will go vacant during prime time, consider this:

You can derive tax-free income from renting your place, provided you rent it out for 15 days or fewer and don't claim any of the tax deductions typically allowed on rental property such as for depreciation or maintenance.

This option can come in handy for folks who do not want to be in the rental game, yet occasionally find they could rent their place.

The rules change, however, if the getaway house becomes a rental or investment property. Under current federal tax laws, the owner can still use a rental vacation home for 14 days or 10 percent of the amount of time the house is rented, whichever is greater, without jeopardizing its status as a rental property and tax shelter.

The owner who rents long-term is getting three benefits:

  • First, the renters are buying the house for you.

  • Second, you still can cash in on any capital gain that might result from increasing property values.

  • Third, you can depreciate the building -- not the property it stands on -- which can provide substantial tax benefits.

The downside, of course, is coping with renters and not be able to use the place yourself.

Depreciating an asset means you are taking a deduction for the value lost as an asset ages. According to the Seattle accounting office of Ernst and Young, the period of time over which you depreciate your property has long been the subject of controversy.

Different taxpayers have depreciated the same type of property over widely different periods. Often, it depends upon when the property was put "in service."

Investors in vacation homes must use the tax benefits from depreciation to cover their costs. What is left for them then is profit made on appreciation in the value of the property.

The 14-day maximum-personal-use rule means a house at the ocean with a 90-day rental season can be owner-occupied for 14 days, instead of the nine days that would be allowed under the 10 percent rule. With longer rental seasons, however, the 10 percent rule can be a bonus. For example, a mountain resort home near winter ski slopes and summer lakes might be rented for 250 days a year, allowing the owner to use it for 25 days.

Personal use does come at a cost. Depreciation is limited only to the percentage of time that a house is rented. If you rented for 90 days and use it yourself for 10, you can take only 90 percent of the total expenses and depreciation.

But another way to catch a few hours at the beach without eating into or exceeding the 14-day or 10 percent limit is to clean the house yourself between renters. Days spent maintaining the house do not count toward the personal-use limit. And you can deduct travel costs to get to the house and expenses such as paint and cleaning supplies.

But if the Internal Revenue Service determines that you were at the house more to sit in the sun than to clean the bathrooms and paint the porch, those days may be added to your personal use and could jeopardize your tax savings.

The house also must be rented at fair market value. If you rent to relatives at discount rates, the IRS may rule that the house is not a business and disallow many of your deductions. One of the more effective uses of a vacation home as a tax shelter is for future retirement. For example, if you are 50 years old, you can buy a vacation home, furnish it and have renters pay for it while you capture the depreciation for 15 years. When you've gotten every shred of tax advantage out of it, you can move in and convert it to a private residence.

The timing would be particularly beneficial because you could take your capital-gains tax exemption (up to $500,000 for a married couple; $250,000 for singles) when you sell your old home, providing a cash "security blanket."

And because most mortgages "front-load" interest, you will have used up most of your tax deductions from the mortgage in the 15 years you worked and rented the home.

In the later years of the mortgage, when interest deductions are relatively low, you probably will be less concerned because your income will have fallen off after retirement. So, the woman who is taking a three-week vacation to Idaho and renting out her place . . . Well, she might be better only renting out for only two weeks. That way, there could be fewer red flags.



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