9.7 Personal Use and Rental of a Residence During the Year
The number of personal-use days and fair-market-rental days for your residential unit determines how you must report rental income and expenses. If rental use exceeds 14 days and your personal use of the unit exceeds the 14 day/10% limit described below, the unit is treated as a residence rather than rental property. If it is treated as a residence, some of your rental expenses are deductible only to the extent of the rental income from the property (9.9).
Personal-use days include not only your days of personal use but may also include rental days to family members listed at 9.6 and use days under co-ownership agreements. See 9.8 for details on personal-use days.
The daily-use tests apply to any “dwelling unit” you rent out that is also used as a residence during the year by yourself or other family members. A dwelling unit may be a house, apartment, condominium, cooperative, house trailer, mini motor home, boat, or similar property with basic living accommodations, including any appurtenant structure such as a garage. A dwelling unit does not include property used exclusively as a hotel, motel, inn, or similar establishment.
The hotel/motel/inn exception applies only to property that is used exclusively in such a business. The exception does not apply to the dual-use portion of a hotel, inn, or bed and breakfast. In one case, the Tax Court agreed with the IRS that the owners of a three-floor bed-and-breakfast could not claim business expense deductions for depreciation or interest on the areas that were used both in the B&B business as well as by them personally. The lobby, registration area, office, kitchen, and laundry room were used 75% of the time for the business and 25% of the time for personal purposes. Because these areas were not used solely for operating the B&B, they could not qualify for the hotel exception. The dual-use areas were treated as part of the owners’ dwelling unit for purposes of the 14-day/10% personal-use test.
Rented less than 15 days during the taxable year.
If you rent the unit for fewer than 15 days in the taxable year, you do not report the rental income and the only deductions allowed are those you would be allowed anyway as a homeowner. That is, if you itemize deductions on Schedule A, you deduct mortgage interest, real estate taxes, and casualty losses, if any. No other rental expenses such as depreciation and maintenance expenses are deductible. Interest is generally fully deductible if the home qualifies as a first or second home under the mortgage interest rules discussed in Chapter 15.
14-day/10% personal-use test applies if unit rented 15 days or more in the taxable year.
A daily-use test determines whether your use of the unit during the taxable year is treated as residential use that requires you to limit your deductions to the rental income under the rules governing the allocation of expenses of a residence to rental days (9.9). You are considered to have used the unit as a residence if your personal-use days during the year, determined according to the rules for counting personal-use and rental days (9.8), exceeded 14 days, or, if greater, 10% of the days on which the unit was rented to others at a fair market rental price.
When the unit is treated as a residence, rental expenses are deductible on Schedule E only to the extent of rental income, following the allocation rules (9.9). Expenses not deductible in the current year under this limitation may be carried forward and will be deductible up to rental income in the following year. The deduction limit is irrelevant if your rental income exceeds expenses. You report the rental income and claim the deductible expenses on Schedule E.
If your personal-use days do not exceed 14 days or 10% of the fair market rental days, whichever is more, your rental deductions on Schedule E (Form 1040) are not limited to rental income by the personal-use test. However, a loss deduction is subject to the passive activity loss restrictions (10.1). Furthermore, you lose part of the mortgage interest deduction because the unit is not a qualified second home for mortgage interest purposes if personal use does not exceed the greater of 14 days or 10% of the fair market rental days. The interest allocable to the rental use (9.9) is deductible against rental income on Schedule E, but the balance is nondeductible personal interest.