Tax Tips
Make Your Vacation Home Less Taxing - July 2008
Richard Scrivanich - Partner
If you own a second home that you use personally and rent to others as well, the tax treatment may vary each year depending on how you use the home. For any given year, the home will be considered either a residence or a rental property - and taxed accordingly.
Residence or rental?
For the best tax treatment, try to keep your personal use of the home down. If you use your vacation home less than the greater of (1) 14 days or (2) 10% of rental days, the home will be considered rental property. If you go over these thresholds, your second home will be classified as a residence and deductions are limited.
If your home qualifies as rental property, you can deduct repairs, maintenance, insurance, and depreciation costs. If your expenses exceed your income, you can deduct the loss, subject to the passive loss rules. In most cases you may deduct passive losses up to $25,000 if your adjusted gross income (AGI) is under $100,000. As your AGI increases, your ability to deduct passive losses decreases, phasing out at $150,000 in AGI.
If you're over the 10% limit, your home is classified as a vacation home and the tax rules are stricter. You can deduct expenses only up to the amount of rental income, so no loss deductions are permitted. What's more, expenses for a residence that's rented to others may be treated unfavorably. Before you can deduct any operating expenses or depreciation, you have to use up a portion of the property's mortgage interest and property tax - based on the number of rental days - effectively wasting deductions.
Losing the numbers game
To see how the tax rules can work against rental use of a residence, consider the hypothetical example of Ann Anderson, who owns a second home in Arizona. In 2008 she rents the house to vacationers for 150 days, collecting a total of $20,000. Ann uses the house herself for 20 days. Thus she's over the 10% threshold and must treat the house as a residence.
Ann is allowed to use $20,000 worth of deductions to match her rental income. Her mortgage interest and property tax on the house are $16,000 in 2008. Of that $16,000, 88% (150 days out of 170) is allocated to rental use. Thus, Ann can use $14,080 worth of mortgage interest and property tax deductions to offset her rental income. The other $1,920 can be deducted on her personal return.
If she hadn't rented the house, Ann could have deducted all $16,000 on her personal return, so she didn't benefit by using that $14,080 to offset rental income.
After deducting $14,080 for mortgage interest and property tax, Ann can deduct only another $5,920 in 2008 against her vacation home income. That's true regardless of whether her operating expenses and depreciation are $6,000, $10,000, or more.
Pare personal use
If Ann had used her vacation home for only 14 days, she could have treated the home as rental property. Then she could have deducted all related expenses, subject to the passive loss limits.
Therefore, if you have a vacation home you also rent out, your first goal should be to keep personal use to 14 days or less. Then no matter how many rental days you have, you can treat the home as rental property. If your personal use is over 14 days per year, try to rent the property for enough days so that personal use does not exceed 10%.
Enter the AMT
The above example of Ann Anderson assumes she is not subject to the alternative minimum tax. (AMT). If she is, her property tax outlays won't be deductible for AMT purposes, which can affect the residence-versus - rental math.
If you have any questions regarding the above discussed topic, or any other tax matter, please feel free to give me a call at (562) 698-9891.
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Some of the articles included here were written in a prior
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relate only to the year for which the article was written and could be different
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