Owning a vacation home can be expensive and many owners rent out the property to help pay expenses and benefit from some tax breaks. But to get those tax benefits, you must be careful how the property is used.

A vacation home’s value as a tax haven depends on:

  • How much you rent it out.
  • How much rent you collect.
  • How wealthy you are.
  • How much you use it yourself.
  • Who you allow to use the place.

Basically the IRS treats your ski condo or beachfront villa as either a residential property or a rental property.

A residential property is one you personally use either more than 14 days a year or for more than 10 percent of the rental days, whichever is greater. On a residential home, you can deduct expenses up to the amount of rental income for the year, but you can’t deduct any losses. Expenses that can’t be written off in one year can be carried forward.

A rental property is one you personally use for 14 days or less a year. Even if you use the house more than 14 days, your house is still rental property if your personal use doesn’t exceed 10 percent of the days it’s rented.

Taking deductions for a rental property is complicated, but here’s a list of the items you need to be aware of:

Expenses You can deduct expenses such as mortgage interest, property taxes, and insurance.
Losses You can write off such passive losses as maintenance, repairs and depreciation.
Restrictions Passive loss deductions are likely to be limited to $25,000 a year by “passive activity” rules that apply when you don’t actively manage the property.
Carry forwards Passive losses can be carried forward, but this may take several years to do you any good. For many, the only way to deduct all the passive losses is to sell the property.
Income Passive loss deductions decrease as your income grows. If your adjusted gross income (AGI) is more than $100,000, you can deduct less than $25,000. With an AGI over $150,000, you can deduct passive losses only if you have other income.
Sales When you sell the property, all passive losses are fully deductible – including any carry forwards — no matter how high your AGI. Check with your tax advisor to assist you in handling this transaction.