A soft real estate market in many areas has led to buying opportunities in vacation or second homes. But did you know that your vacation or second home provides more than a weekend getaway? In order to make the best tax use of your vacation home, you should be aware of the basic tax laws.
Tax Free Vacation Home Income
A taxpayer who rents his vacation home for less than 15 days during the year does not have to report any rental income and cannot claim most offsetting vacation home deductions. Some expenses, however, such as mortgage interest, property taxes and casualty losses may still be deducted. This provides taxpayers, whose homes are located in prime vacation spots, the ability to bring in a substantial amount of income in just a few days without having to report any of the income.
The IRS defines a qualified residence as a house, condominium, cooperative, mobile home, house trailer, boat, or similar property that has sleeping, cooking and toilet facilities. If you rent your vacation home for 15 days or more during the tax year, you must use the home for personal purposes for the greater of 14 days or 10% of the days the property is rented. Meeting these requirements will allow your vacation home to be considered a “qualified residence,” thus allowing you the opportunity to take advantage of the vacation home tax breaks. This includes being able to fully deduct the personal-use portion of the year’s mortgage interest and real estate taxes.
Expenses related to the rental-use portion of the home can be deducted up to the amount of the rental income you received. Examples of deductible expenses include utilities, maintenance, upkeep, mortgage interest, real estate taxes, insurance and travel expenses.
If your rental expenses are more than your rental income, you cannot use the excess expenses to offset income from other sources. The excess can be carried forward to the next year, and can be treated as rental expenses for the same property. If you do not use the property as your home for that year, you can deduct the expenses carried over for a year up to the amount of your rental income for that year.
Tax Free Sale
Vacation homes used as residences may also qualify for the up-to $250,000 exclusion ($500,000 for qualifying married taxpayers) on the sale of the home, if they plan and structure the sale carefully. For example, a taxpayer decides to sell his home at retirement and move into what was considered his vacation home. If the vacation home is later sold, gain on the sale of both homes is eligible for the tax exclusion. This is allowed if each home is owned and used as a principal residence for at least two of the five years preceding each of the sales and at least two years elapse between the sales.
Beware of a small caveat that exists concerning the sale of your vacation home in the scenario described above. Any part of the gain on the sale attributable to post May 6, 1997 depreciation is not eligible for the exclusion and must be recaptured. When you consider this exclusion, you are paying the taxes you saved when you were allowed in earlier years to deduct the depreciation. This is a small price to pay considering the fact that you can exclude up to $250,000 in gains ($500,000 if married filing jointly).
For details about the tax treatment of vacation homes that are considered to be rental property (i.e., you rent the vacation home, but the personal use does not exceed the greater of 14 days or 10% of the days the property is rented), please read our article “Rental Income and Expenses” located in Henssler University.
If you would like additional information regarding this topic or any other tax related issue, please contact Henssler Financial at 770-429-9166, or [email protected]