Tax Tips
Vacation Home Tax Rules - March 2005
Richard Scrivanich - Partner
Tax Rules for Your Vacation Home
Owning a vacation home gives you a great opportunity to relax and have fun. To add to your enjoyment, a vacation home also can provide significant tax benefits. Here’s what all current and would-be vacation homeowners should know.
Deductions for vacation home owners
Most people can fully deduct mortgage interest and property taxes on their vacation homes just as they can with a personal residence. Under current tax law, interest is deductible on the first $1 million in mortgage debt used to buy, construct, or improve a principal residence and second home. If you have more than one vacation home, for tax purposes you’ll want to designate as your second home the residence with the largest total deductions for mortgage interest and real estate taxes. Property taxes may be deductible no matter how many vacation homes you own.
High-income homeowners may not get the full benefit of these tax breaks, however, since most itemized deductions, including mortgage interest and property taxes, are reduced once adjusted gross income exceeds certain levels.
If you rent your vacation home, you may be entitled to extra tax benefits. But the applicable rules depend on the use of the home
Minimal rental brings tax bonus
If you rent your home for no more than 14 days a year, any rental income you collect is tax-free. However, any rental-related expenses you incur from renting your home for 14 days or less are not deductible.
Combining personal and rental use
If you rent your vacation home for more than 14 days a year and you and your family use the place more than 14 days a year (or 10 percent of the number of days it is rented, whichever is greater), a different set of rules applies. In this case, all of the rental income is subject to tax, but you can deduct rental income after taking the allowable deductions for property, such as real estate taxes and mortgage interest. You also can carry forward to future years expenses for the rental period that cannot be currently deducted.
Limited personal use leads to greater tax benefits
If you use your vacation property for personal use for less than 14 days (or 10 percent of the total rented days, if greater), vacation home qualifies as a rental property. That status makes it possible to write off more expenses-as much as $25,000 in excess of rental income. This extra deduction phases out when your adjusted gross income exceeds $100,000 and is completely unavailable above $150,000.
In general, you can deduct passive losses only from passive income, such as from rental properties that produce income or gains. There are additional rules about the order and limitations for deducting expenses.
The fine print: defining personal use
There are complicated rules for determining what constitutes personal use. According to tax law, days you spend repairing and maintaining your home on a full-time basis do not count as personal use, even if other family members use the home during the same time period for recreational purposes. On the other hand, if you allow family or friends to use your home for free or at a below-market rental rate, be prepared to classify that time as personal use.
Selling your vacation home
When it is time to sell your vacation home, the gain exclusion of up to $250,000 ($500,000 on a joint return) on the sale of a principal residence does not apply. To qualify for the exemption, you would need to make the vacation home your principal residence for at least two of the five years before the sale.
If you have any questions regarding the tax rules for your vacation home or any other tax matter, please call me at (562) 698-9891.
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