Vacation Home Tax Rules

The IRS classifies a vacation home based on how much it is used personally, applying different tax rules to each category. If personal use exceeds 14 days or 10% of rental days, the property is treated largely as personal, and deductions are severely limited. Below that threshold, the property is a rental, and deductions follow rental rules—but gains and losses are still subject to residential real estate constraints.

The 14-day / 10-percent test

The centerpiece of the vacation home rule is a bright-line test: if personal use exceeds 14 days or 10% of the days rented at fair market value (whichever is greater), the property is classified as personal use and taxed accordingly.

Example: A lakehouse is rented 200 days of the year at fair market rates. Ten percent of 200 is 20 days. The owner uses it personally for 15 days. Since 15 exceeds 10% (20 days), the property is treated as personal use, and deductions are capped. If the owner had used it for only 10 days, the property would qualify as rental.

Example 2: The same owner rents the lakehouse for only 80 days per year. Ten percent of 80 is 8 days; the greater threshold is still 14 days. The owner uses it for 16 days, exceeding 14, so the property is personal use again.

The 14-day threshold applies even if the property is rented fewer than 140 days per year. An owner who rents a beach condo for 30 days but uses it personally for 15 days is still classified as personal use, because 15 exceeds 14.

Counting personal-use days

Not all days at the property are counted equally. A personal-use day includes:

• Days the owner or immediate family lives in it
• Days the owner repairs, renovates, or maintains the property (if occupied)
• Days rented to family or friends at less than fair market rent (treated as personal use, not income)
• Days spent during a short stop-over while traveling to rent it out

A day counts as personal use even if the owner is there only briefly—an hour is enough. Days with professional contractors working on renovation do not count as personal use (the owner need not be present).

Days when the property is being shown to prospective buyers or tenants, days when the owner is preparing it for rental, and days when a property manager is present (without the owner) all count as rental days, not personal.

Fair market rent is key: if the owner rents it to his brother for $50 per night when comparable units rent for $200, the discounted days count as personal use. The IRS examines whether the rent charged reflects what an arm’s-length third party would pay.

Above the threshold: limited deductions (mostly personal)

When personal use is excessive, the property is classified as a residence (not a rental), and mortgage interest and property taxes are deductible as itemized deductions on Schedule A—but only if the owner itemizes. Mortgage interest is capped at loans of $750,000 or less (the SALT cap limits state and property taxes to $10,000 combined), and family use of the residence may invoke imputed income rules under Section 280A(e).

Rental income must still be reported on Schedule E, but deductions for operating expenses, depreciation, and repair work are severely limited. The rule: deductions can offset rental income, but cannot create a net loss that shelters other income. Any excess deduction is carried forward and may be used only in years when the property generates positive rental income.

Example: A vacation home rents for $15,000 and incurs $20,000 in operating expenses and $8,000 in depreciation. Only $15,000 can be deducted; the excess $13,000 is suspended. If next year the property rents for $18,000 and incurs $12,000 in expenses, the suspended $13,000 can now be used, reducing the current-year taxable income on the property.

This effectively turns the vacation home into a wash: the owner pays tax on the rental income but cannot use excess deductions against other income.

Below the threshold: full rental treatment

When personal use is 14 days or less (and also ≤10% of rental days), the property is a rental. All rental income is reported on Schedule E, and all ordinary and necessary expenses—utilities, repairs, property management fees, depreciation, insurance, and property taxes—are deductible.

If expenses exceed income, a rental loss is generated. For taxpayers not classified as real estate professionals, this loss faces the passive loss limitation: it can be deducted only against passive income, or up to $25,000 against active income (phasing out above $100,000 in adjusted gross income). But for real estate professionals, the loss is fully deductible against wages, dividends, and other active income.

Depreciation is a major benefit at the rental level. The owner can depreciate the building (not the land) over 27.5 years. A $300,000 building generates roughly $10,900 in annual depreciation deductions, reducing taxable rental income. On sale, that depreciation is recaptured and taxed at a 25% rate—higher than the long-term capital gains rate—but the deferral is still valuable.

Mixed-use conversions and timing

An owner who buys a vacation home for personal use but later converts it to a rental must treat the property as two separate activities. If the owner lives in it for 60 days and rents it for 100 days in year one, the property is personal use. In year two, if the owner uses it only 8 days and rents it for 150 days, it becomes a rental.

The depreciation deduction begins only when rental use starts; prior personal-use years generate no depreciation allowance. When the property is sold, the cost basis is split: the personal-use portion uses adjusted basis at the time of conversion (usually the fair market value on the date the owner stops using it personally), while the rental portion is adjusted by depreciation.

Interaction with Section 121

The Section 121 primary residence exclusion—allowing $250,000 to $500,000 of gain to pass untaxed on the sale of a principal residence—does not apply to vacation homes. A vacation home is not a principal residence for purposes of Section 121; it is a second home.

However, if an owner converted a vacation home to a principal residence (by living in it and not renting it out for two of the five years before sale), and satisfies all other Section 121 tests, gains on that portion are excluded. The pre-conversion rental-use period disqualifies gains on depreciation taken and allocates a portion of gain to the rental period, which is always taxable.

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