J.K. Lasser's Your Income Tax 2013: For Preparing Your 2012 Tax Return

9.9 Allocating Expenses of a Residence to Rental Days

When you rent out your home or other dwelling unit (9.7) for part of the year at fair market value and also use it personally on some days during the taxable year, expenses are allocated between personal and rental use. By law, deductible rental expenses are limited by this fraction:

The days a unit is held out for rent but not actually rented are not counted as rental days. Any day for which the unit is rented at a fair rental price is counted as a rental day for allocation purposes even if in fact you use it for personal purposes on that day.

Mortgage interest and real estate taxes.

There is a conflict of opinion between the IRS and some courts over the issue of whether the above fractional formula applies also to interest and taxes. According to the IRS, it does. According to the Tax Court and two federal appeals courts, interest and taxes are allocated on a daily basis. Thus, if a house is rented for 61 days in 2012, 16.67% (⁶¹/₃₆₆) of the deductible interest and taxes is deducted first from the rental income. This rule allows a larger amount of other expenses to be deducted from rental income than is allowed under the IRS application of the formula; see Example 2 below.

Claiming expenses on Schedule E if personal use limits a loss deduction.

If your personal use of a residence exceeds the 14-day/10% test (9.7), the residence ...