The Tax Consequences Of Renting Your Condo
By ohn R. Shields, CPA, Crow Shield Bailey, PC, April 26, 2013
The tax treatment of renting your condominium depends on how many days it’s rented and your level of personal use.
If you rent your unit out for less than 15 days during the year, it’s not treated as “rental property” at all and any rent you receive isn’t included in your income for tax purposes, no matter how substantial the amount. On the other hand, you can only deduct property taxes and mortgage interest—no other operating costs and no depreciation. Mortgage interest is deductible on your principal residence and one other home, subject to certain limits.
A good example of where such short-term rentals occur is in Augusta, Ga. during the Masters Golf Tournament, where residents rent their property for a week or two in April. But here on the Gulf Coast and most other places, owners generally rent out their property for longer periods. In that case, all rent received must be included in income, with a part of the interest, taxes, operating expenses and depreciation being deductible. The portion of deductions allowed depends on your level of personal versus rental use.
If you use your unit personally for more than the greater of (a) 14 days, or (b) 10% of the rental days, you cannot claim expenses in excess of income. You can still use your deductions to offset rental income, but these deductions cannot exceed income to create a loss. Any deductions you cannot use carry forward and may be usable in future years
If you “pass” the personal-use test by not using the property personally more than the greater of the figures listed above, and your rental deductions exceed income, you may be able to claim a loss. However, you must still allocate your expenses between the personal and rental portions.
Let’s look at a couple of examples.
Example 1 – Personal Use Test “Passed”: You rent your unit for 90 days and use it personally for 10 days. You are paid rent of $12,000. Expenses are $6,000 in interest and taxes, $3,600 in operating costs such as insurance, monthly dues, assessments, utilities and repairs, and $6,000 of depreciation, for a total of $15,600. Personal use is 10% (10 out of 100 total use days). So 90% of expenses are allocated to rental ($15,600 × 90% = $14,040). You can deduct the 90% rental portion of the interest and taxes, or $5,400, then 90% of operating costs and depreciation, or $8,640.This produces a rental loss of $2,040 ($12,000 income less $14,040 expenses). Since personal use does not exceed the greater of (a) 10 days and (b) 10% the loss is allowed subject to the limitations under the “passive activity” rules. Note that the remainder of the interest and taxes of $600 (10% of $6,000) may be deductible if you itemize deductions, subject to certain limitations.
Example 2 – Personal Use Test “Failed”: You rent your unit for 60 days and use it personally for 20 days. You are paid rent of $8,000. Expenses are the same as in Example 1: $6,000 in interest and taxes, $3,600 in operating costs and $6,000 of depreciation, for a total of $15,600. This gets a little more complicated, as there are two methods available in allocating expenses to your rental income as follows:
Note that even though your total deductions exceed your rental income by $7,600, you may not claim that loss on your tax return since your personal use exceeded the 14-day/10% of rental day’s threshold. Your net reportable income is zero under both Methods.
Interest and taxes must be allocated first, followed by operating expenses and then depreciation. Each Method allocates operating expenses based on rental days (60) to total days of use (80), and each allows only enough depreciation to bring deductions up to the amount of income. However, Method 1 allocates interest and taxes based on rental days (60) over total days of use (80), while Method 2 allocates less interest and taxes to rental by using a ratio of rental days (60) over total days in the year (366 for 2012). The advantage of Method 2 is that more interest and taxes remain available to deduct as an itemized deduction. So this method can result in more deductions and less tax. Although the Tax Court and the Ninth and Tenth Circuit Courts have allowed Method 2, the IRS doesn’t agree and takes the position that Method 1 is correct. Nevertheless, the more favorable court-allowed Method 2 is commonly applied by taxpayers. You should consult your tax advisor as to which method is best for your situation.
We hope you find this information useful in understanding the tax consequences of renting out your condominium. If you have questions please contact us or feel free to stop by our office.
Crow Shields Bailey, PC is a Certified Public Accounting firm practicing in Gulf Shores and Mobile for over 27 years. You may visit their website at www.csbcpa.com for more information.
Circular 230 Disclaimer: This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer
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