Income Tax Rules for Cottage Rentals

Dec 6

**It’s a decision that many cottage owners face: they want to earn extra money when not using their cottage, but they are worried about the hassles that come along with owning a rental property.**

It is well known that renting out a cottage is not without some downside. Issues include deciding whether you want to open up your personal space to guests, whether your cottage’s insurance is affected by renting and whether your cottage is truly in rentable condition. You may also be concerned that the arrangement will create tax consequences.

One of the most confusing aspects of renting a cottage is determining how the rental deductions are treated for federal income tax purposes. Different tax rules apply depending on the breakdown of personal and rental use of the cottage. Simply put, the amount of time that you spend at your cottage determines the extent to which your cottage expenses are deductible.

**There Are Three Categories With Respect to Tax Consequences and Cottage Use**

1) Mostly Rental Use

Where a cottage owner uses the cottage for personal purposes for less than the greater of 14 days or 10% of the time that the cottage is rented, then the cottage is treated as rental property for tax purposes. The cottage will not be treated as a personal residence and, thus, a cottage owner can typically deduct many of the rental expenses associated with the cottage. Common rental expenses include mortgage interest, property management fees, repairs, taxes, utilities, advertising, and legal and other professional fees.

Alternatively, those expenses that are attributable to general cottage maintenance and ownership, like property taxes, depreciation and utilities, will be divided into personal expenses and deductible rental expenses in proportion to the rental use of the cottage. Apportionment of these expenses is accomplished based on a fraction of the total, the numerator of which is the number of days the home is rented at a fair rental, and the denominator of which is the total number of days the home is used for any purposes.

Cottage Property Risks

2) Mixed Personal and Rental Use

Where a cottage owner rents the cottage for more than 14 days each year, but also uses it for personal purposes for the greater of at least 15 days each year or 10% of the total time the cottage is rented, the rental income from the cottage will be taxable income that needs to be reported on the owner’s tax return. As far as tax deductions are concerned, not only do the previously discussed apportionment rules apply, but a cottage owner is also only allowed to take rental deductions to the extent that he or she actually earns income from renting the cottage. On the plus side, because your cottage qualifies as a personal residence, you can still generally deduct the mortgage interest for the cottage if you treat the cottage as your second home.

Cottage Succession Planning Terms

3) Mainly Personal Use

This area represents a change in the tax code. If a cottage owner uses the cottage as a personal residence and only rents it out for 14 or fewer days each year, then the owner does not need to report any of the rental income earned during those days as taxable income on a tax return. The only downside to this treatment is that expenses incurred in connection with renting the cottage are generally not deductible under these circumstances.

This information is intended only as a basic introduction to some of the tax issues that cottage owners who rent out their properties face. Because these rules are so complex, and the matter of one day can make a difference on your tax liability, you may want to seek the advice of your tax and/or legal professional to assist you in determining your tax liability and the extent to which deductions apply.