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How to Earn Tax-free Rental Income From your Home and Vacation Home

Close up of man's hands work on phone representing tax-free rental income

How did one of golf’s biggest events create a unique tax break allowing you to rent your home tax-free?

Every April, the best golfers in the world gather in Augusta, Georgia, to play “The Masters” golf tournament. The tournament is played at the exclusive Augusta National Golf Club.  Tickets to the event can be one of the most difficult to get in sports. The waiting list to get a regular “Patron” badge began in 1972 and currently lasts decades. Most fans rely on luck and prayer using the tournament’s ticket lottery system. Others try to buy one on the secondary market for a steep price!

Both local residents, and members of the golf club with vacation homes in the area, can make easy money renting their homes for the week.

The story goes that in the 1970s, legislators were reviewing the tax rules around renting personal residences. They were potentially going to change tax laws related to renting your home. A group of influential people, many from Augusta, lobbied congress to be able to keep a tax break allowing for certain short-term rentals to be tax-free. No surprises here, having friends in the right places worked. With rentals during “The Masters” going for up to $25,000 a week, this was a big tax break. This is now known as “The Masters Exception”.

How Does the Rental Income Tax Break Work?

Section 280(A)(g) of the tax code is where renters can find their tax-free income.

This rule reads:

(g)Special rule for certain rental use

Notwithstanding any other provision of this section or section 183, if a dwelling unit is used during the taxable year by the taxpayer as a residence and such dwelling unit is actually rented for less than 15 days during the taxable year, then—

(1) no deduction otherwise allowable under this chapter because of the rental use of such dwelling unit shall be allowed, and

(2) the income derived from such use for the taxable year shall not be included in the gross income of such taxpayer under section 61.

Simply put, if you rent your home for less than 15 days a year, you do not need to report or pay tax on any of the income. Unlike traditional rental property, you can’t deduct any expenses related to renting out your property for that time period though. That’s still a deal worth taking. You can of course still claim the usual homeowner deductions of mortgage interest, property taxes, and casualty losses.

Tax-Free Rental Income from your Vacation Home

This tax break also applies to a vacation home if it qualifies as a personal residence. From the IRS:

A home is considered a residence if you use it for personal purposes during the tax year for more than the greater of :

    1.  14 days, or
    2.  10% of the total days you rent it to others at a fair rental price.

It’s possible that you’ll use more than one dwelling unit as a residence during the year. For example, if you live in your main home for 11 months, your home is a dwelling unit used as a residence. If you live in your vacation home for the other 30 days of the year, your vacation home is also a dwelling unit used as a residence unless you rent your vacation home to others at a fair rental value for 300 or more days during the year in this example.”

Be aware that depending on where the home is, you still could have state, local, and lodging taxes involved. This law relates to federal tax returns only.

Options for renting your home

If you choose to earn some tax-free income by renting your home, you have some options. You can take the do-it-yourself approach. Or you can use options such as Airbnb and Vrbo. Hosting fees on Airbnb can range from 3% to 15%. But using them can transfer some risk, liability, as well as time and effort from yourself to Airbnb.

Know that if you choose to use the likes of Airbnb and Vrbo, because of reporting laws they may still report the income to the IRS, even if you rent for less than 15 days. If you did not include the income on your return, there is a chance the IRS reaches out. Don’t worry, you will simply need to show that you qualify for this tax-free income exception. If that last line makes you nervous, let me remind you to consult a tax professional when doing this, especially when it’s a vacation home.

The next time you are planning a vacation, you could rent out your empty home to earn some extra income…tax-free!

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