Katy owns a second home. During the year, she used the home for 20 personal use days and 50 rental days. Katy allocates expenses associated with the home between rental use and personal use. Katy did not incur any expenses to obtain tenants. Which of the following statements is correct regarding the tax treatment of Katy's income and expenses from the home?

Question

Quizplus · Accepted Answer

A) Katy includes the rental receipts in gross income and deducts the expenses allocated to the rental use of the home for AGI. This is correct as rental income is taxable and expenses associated with the rental use of the home can be deducted to arrive at the net rental income, which is then included in AGI.
B) Katy deducts from AGI interest expense and property taxes associated with the home not allocated to the rental use of the home. This is also correct as any expenses associated with the personal use of the home cannot be deducted against rental income. 
C) Assuming Katy's rental receipts exceed the interest expense and property taxes allocated to the rental use, Katy's deductible expenses for the year may not exceed the amount of her rental receipts (she may not report a loss from the rental property). This is also correct as passive activity losses from rental activities are subject to limitations and cannot be used to offset other sources of income. Therefore, if Katy's rental expenses exceed her rental income, she cannot report a loss on her tax return.

Katy Owns a Second Home