If you own a home that you live in part of the year and rent out part of the year, prorate the expenses you incur between personal and rental use. Since vacation homes usually get this kind of treatment, the rules you must follow are known as vacation-home rules.
Home Used Mostly by the Owner
If the home is your main home and you rent it out for fewer than 15 days during the year, you don't need to report income. However, you can't deduct expenses associated with the rental. You can, however, claim the usual homeowner deductions for:
Mixed Use by Owner and Tenant
If you rent the home for 15 days or more, report the rental income on Schedule E. You can deduct expenses, but you must prorate them, and they might be limited.
If the home is considered a residence (see below), the expenses you deduct can't be more than the rental income. However, if the home isn't considered a residence, the expenses you deduct can be more than rental income. However, your loss would be limited by the passive-activity rules.
To be considered a residence, a home must pass both of these tests:
It must provide basic living accommodations. So, it must have a sleeping space, bathroom facilities, and cooking facilities. A residence might be 1 of these:
It must pass the personal-use time test. A home is considered a residence if you use it for personal purposes for more than the greater of 1 of these:
10% of the total number of days you rent the home at fair rental value
Ex: Richard owns a house on the beach. Last year, he stayed in the house 21 days and rented it out at fair rental value for 230 days. The remainder of the year, the house was vacant.
Since he didn't use the home for personal purposes for more than 10% (10%) of the total number of days he rented it, the home isn't considered a residence:
.10 x 230 (days of rental use) = 23 days
The amount of time you personally use a home includes use by:
Any person who has an ownership interest in the home. This is unless the home is rented to another owner as his or her main home under a shared equity financing agreement.
Ex: Agnes and her 2 brothers, Michael and Malcolm, equally own a cottage at the lake. Their agreement allows each to use the cottage for 3 weeks of the year. They try to rent it to vacationers the remaining weeks. The 3-week use by each sibling counts as personal-use days for the other 2. So, each personally uses the cottage 63 days:
21 days (3 weeks) x 3 (owners) = 63 days
A family member of any person who has an ownership interest in the home. This is unless the family member uses the home as his or her main home and pays fair rental value. Family members include:
Brothers and sisters
Half-brothers and half-sisters
Lineal ancestors like parents or grandparents
Lineal descendents like children or grandchildren
Ex: If Richard (from the previous example) lets his brother stay in his beach house for a week at no charge, he must add 7 additional days to his personal-use count. So, he personally used the house for 28 days. The home is now considered a residence since Richard used it for more than 23 days (10% (10%) of the 23 days he rented it).
Any person who pays less than fair rental value to use the home. This doesn’t apply to an employee who uses the home as lodging at the owner / employer's convenience.
Any person who uses the home under a home-exchange arrangement with the owner -- regardless of if the use is rent-free or paid.
If a tenant paying fair rental value allows the owner to stay in the home, the time is considered personal use when determining if the dwelling is a residence. However, when determining the ratio for prorating expenses, the time is counted as rental use. (See Rental-Use Time below.)
Any time you spend at the home repairing and maintaining it doesn't count as personal-use time.
You must count the number of days of rental use to determine the ratio to prorate expenses. Rental use is any day you rent the dwelling at a fair rental value. So, you can only count the days when you actually receive rent payment to calculate the ratio.
How to Prorate
To figure the proration rate, divide the number of days you rented the home at fair rental value by the total days used for both personal and business purposes. This method applies to all rental expenses.
Ex: Elaine bought a house on March 2 of last year to use as a vacation home. During the year, she spent 33 days there and rented it at fair rental value for 128 days. The rest of the year, the house was vacant. Her proration rate is 79.5%:
She must prorate all expenses she incurred last year relating to the house by this percentage before deducting them from rental income.
What if My Home Qualifies as a Residence?
If you rent out your home for at least 15 days and the days of personal-use qualify your home as a residence, vacation-home rules apply. These rules limit deductible expenses to rental income. And you must deduct expenses in this specific order:
The rental portion of:
Qualified home mortgage interest
These expenses are deductible subject to the usual rules, but you can only subtract the rental portion from rental income. The personal portion is deductible on Schedule A and subject to the usual rules.
Rental expenses directly related to the rental property itself, including:
Expenses related to operating and maintaining the rental property up to the amount of rental income minus the deductions for items in 1 and 2 above. This includes interest that doesn't qualify as home mortgage interest.
Depreciation and other basis adjustments to the home up to the amount of rental income minus the deductions for items in 1, 2, and 3 above. This includes things like improvements and furniture.
To learn how to calculate your deductions, see IRS Worksheet 5-1 and its instructions in Publication 527: Residential Rental Property.
You can carry forward expenses you can't deduct due to the rental income limit. You can use the carryforward in 1 of these time periods:
First year you have sufficient income from the property
When you sell the property
What if My Home Doesn't Qualify as a Residence?
If you didn't personally use the home long enough for it to be classified as a residence, you must prorate the expenses of owning and maintaining the home. You should use this ratio to prorate your expenses: number of days of rental use divided by the total number of days used for business and personal purposes.
However, deductions for expenses aren't limited by rental income. A rental loss can be used to offset other income, subject to the usual passive-activity loss limitations.