Owning a second home may bring great joy to your family. However, it also can be a tax nightmare if you rent out the property.

The easiest tax situation occurs if you use the property for personal use more than 14 days and rent it out 14 days or less in a year. The rent is not treated as taxable income, even if you rent it at very high rates. You can’t deduct rental-related operating or maintenance expenses, but you can deduct the property taxes and mortgage interest on your Schedule A. You can deduct mortgage interest on only two personal residences, so if you own a residence plus two or more vacation home, you can deduct mortgage interest on only one of the vacation homes.

It gets more complicated if you rent out for more than 14 days. Let’s say you rent out 150 days during the year and you vacation there 15 days. According to the tax rules, since you haven’t personally used the property for more than 14 days or ten percent of the total rental days, whichever is greater, the property is considered rental property.

Now you’ll have to report all rental income on Schedule E, Supplemental Income and Loss. However, you can now write off rental expenses, including not only direct rental costs such as property management fees, but also a portion of your homeowner’s insurance, mortgage interest, property taxes, maintenance and depreciation. This is based on the total number of days the vacation home is used. In our example, that’s a total of 165 days, so you allocate 91 percent of the expenses against the rental income (150/165 days = 91%).

What happens if rental expenses exceed rental income, known as &uot;passive losses&uot;? Normally, passive losses can only be deducted against other passive income, which is income from an activity you did not &uot;materially participate&uot; in, such as a limited partnership. Tax rules may let you write off as much as $25,000 in passive rental income losses if you actively participate in renting out your second home, such as making the day-to-day property management decisions. However, this write-off phases out for taxpayers with adjusted gross income between $100,000 and $150,000.

What if you rent your house out for more than 14 days, but also personally use it for more than 14 days or ten percent of the total rental days? Then it’s considered a residence, not rental property, and you allocate expenses between the rental and personal side. However, in this situation you allocate in different ways for different expenses. When deducting mortgage interest and property taxes, all days in which the home is not rented will be considered personal days, whether you are there or not. In the above example, 150 days out of the year would translate to roughly 41 percent of all costs. The remaining 59 percent is an itemized deduction on Schedule A.

However, when calculating the portion for operating expenses, such as maintenance, depreciation, insurance, property management fees, utilities and so on, you figure the percentage based on the total number of days you actually vacationed there plus the total rental days, which was 165 days, or 91 percent, on our example. You can’t claim passive losses, but you can carry the losses forward.

Just to add one more complication, the law is a little tricky regarding what constitutes personal vacation days. Any time you rent out below fair market rates, such as to friends, donate its use to charity, or let close relatives use it (whether you charge them fair market rates or not), it counts as a personal use day.

Also keep in mind that a &uot;second home&uot; can be a boat, a recreational vehicle or a timeshare unit (though a timeshare unit can really be a tax nightmare). Because of the complexity of these rules, you’ll want to consult with your financial planner or tax specialist. For example, due to the passive loss limitation rules, some higher-income owners may actually find it financially better to treat their vacation property as a personal residence because they gain more from the personal mortgage write-off than taking rental deductions. Vacation-home owners also may save capital gains taxes through such strategies as Section 1031 exchanges.

Charles S. Plauche’ is a CERTIFIED FINANCIAL PLANNER. He and John C. Bergeron are partners with Century Investment Group, 507 Franklin Street, Natchez, MS 601-442-0088; 800-308-5388; FAX 601-442-3005