Tax-Free Rental Income

Copyright (c) 2009 Tom Wheelwright

Real estate is one of my absolute favorite areas in the tax law. Why? Because there is so much flexibility in how to do things in order to legally maximize the tax benefits available.

Did You Know You Can Receive Rental Income Tax-Free?

Of course, there are specific rules behind this permanent tax saving strategy. I find that after I go through the rules with my clients, we usually find a way to use this strategy - legally - and it creates another stream of permanent tax savings. Plus, this strategy can be used every year so these are annual permanent tax savings!

General Rule

The rule is applied most often to vacation homes. The rule prevents taxpayers from deducting large expenses as rental real estate expenses for maintaining their vacation home.

The rule states that if you rent your property for 14 days or less per year, then the expenses that are not otherwise deductible are considered personal non-deductible expenses. This means no deduction for utilities, insurance, maintenance or similar expenses. It also means no depreciation deduction.

On the flip side, however, the rental income received is tax-free.

The reasoning behind this rule is that If the expenses were allowed to be deducted, it would likely lead to a large loss because these expenses (even pro-rated for the rental period) typically outweigh the rental income. So, the rule takes a conservative approach by making the expenses non-deductible and the income non-taxable.

Ways to Apply this Strategy

While the rule is most often used in the situation of vacation homes to prevent taxpayers from claiming rental losses on a property rented 14 days or less per year, it can be applied to any property - including your residence!

You've probably heard of people renting their home for a week to out-of-town visitors coming into town for big sports and entertainment venues. As long as the total days rented doesn't exceed 14, the rental income they receive is tax-free.

Now, some of us may not be too excited to rent our home to strangers, but perhaps there are people (or even companies) we know who may want to rent our homes for a short period of time.

As I mentioned previously, usually my clients and I are successful in finding ways to use this great permanent tax savings strategy. At first, many clients don't think it will apply to them, but after they are able to think about it as they go through their day-to-day activities, they find a way to use it - legally!