Turn your Vacation Home into a Profitable Rental with New Tax Laws

Given the demands of life, work and family, even most who are fortunate enough to own a vacation home are not usually lucky enough to be able to spend a significant amount of time there. Why allow a beautiful vacation property to sit empty all but three to four weeks a year when you could be turning a nice secondary profit on it as a vacation rental?

Changes in tax laws have made owning a second home more expensive in some cases; Mortgage interest is limited to a combined $750,000 deduction on new mortgages. This means if someone owes $700,000 on their primary residence they can only deduct $50,000 mortgage interest on a second home. Loans originated before Dec. 15, 2017 are grandfathered into the previous limit of $1 million. By turning your home into a vacation rental, you could potentially change expenses such as interest, maintenance, utilities, property tax and other taxes into deductible expenses.

Furthermore, new tax laws allow a maximum deduction on property tax and state and local tax of $10,000 per year. This does not include rental properties so if you turn the home into a rental, you can still deduct the property tax (this will often be more than the mortgage interest).

Here’s the good news: The demand for privately owned vacation housing is definitely there, and growing, as more and more travelers eschew standard hotels in favor of cheaper, more personal accommodations. According to Phocuswright, in 2015, approximately one in three U.S. travelers stayed in a privately owned short-term rental, a 24 percent increase over 2010. Phocuswright expects the private vacation rental sector to be worth $36.6 billion by the end of 2018 — more than doubling the growth rate of the travel sector as a whole.

There are several ways to approach renting out your vacation property, and multiple tax stipulations to comply with to ensure the most benefit, which will vary depending on how often the property is rented vs. owner-occupied.

In order for it to qualify as a vacation rental, you can only have personal use of the property for 14 days or less per year or ten percent of the amount of days rented — whichever is greater.

If you decide to take advantage of the benefits, renting out your home doesn’t have to be a daunting prospect, but it’s not as simple as merely buying some nice guest towels either.

The first thing to consider when deciding whether to convert your vacation property to a rental is how much investment of time and money you are willing to put forth. Obviously if you’re interested in earning year-round income from your property, you will have to put the means in place to manage it year-round; you can either do it yourself if you have the time and capability, or you can outsource to a management company.

DIY property managers will often use Craigslist, which saves on administrative fees but also opens you up to more risk. There is no vetting of your renters or payment security, but if you have the time to thoroughly research your renters and personally handle payments, it can be a cost effective method.

A management company, on the other hand, can handle marketing your property, in addition to the logistics of rental agreements, payments and maintenance. A management company can also be on-call for any issues that arise, which can be an extremely valuable offering given that many local regulations require someone to be able respond to calls within a certain number of hours — a difficult prospect if your primary residence is further than a few hours drive. In many instances, you can also write off the cost of employing a manager if the property is primarily used as a rental.

The next, and most crucial, step is to determine the ordinances and regulations on rental properties that may apply. Local homeowner’s associations will most likely have regulations specific to rental properties, especially given the rise in rent-by-owner programs like AirBnB and VRBO. AirBnb has become a dominant force in the last five years, which has caused housing markets to put new regulations in place to mitigate risk.

Some regional markets require rental or property management licenses for both short- and long-term rentals. Some classify the type of rental—14 days or less is a vacation rental while 31 days or more is residential—and apply different stipulations to each. Some markets require you as the property owner to charge your renter a “transient occupancy tax,” which is then remitted to the city or county.

You must consider both tax laws and zoning ordinances from the local to federal level when evaluating your property as a possible rental. From HOA to IRS, there are rules, and exceptions, and loopholes, which will all factor into your ability to manage the property and to profit from it. Not to mention, these rules are constantly changing, so you will need to keep a regular eye on them.

An invaluable resource as you consider these options will be your realtors and property managers already operating in the area of your property. A simple call or email to one of these experts can help you get the lay of the land when it comes to managing a vacation rental and maximizing your profit potential. Also, check with the city in which the vacation rental will be located to see if there are any upcoming petitions or measures that will limit your ability to conduct business as a vacation rental. For example, in Palm Springs, a major vacation destination, homeowners are only allowed to rent their properties for 32 weeks out of the year.

It is also highly recommended that you first consult with your accountant before turning your vacation home into a rental.

From there, once you decide how much of yourself you want to put into the process, and the right rental calendar to take advantage of tax breaks and deductions, you can start picking out those guest towels.


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