by Lew Sichelman on October 15, 2010
Uncle Sam offers taxpayers plenty of ways to reduce the cost of owning a beach front house at the shore or a cabin in the woods.
Here is a basic primer on the tax aspects of vacation home ownership. While it is intended solely for information purposes, it will give you a good idea of what's deductible and what's not. For more detailed information, be sure to consult professional tax counsel.
Primary Home vs. Vacation Home
Obviously, if and when your vacation property becomes your primary residence, you are entitled to all the benefits ownership entails. You can write off the interest paid on your mortgage and your property taxes, and you can add the cost of any improvements you make to your basis, or cost.
Moreover, after you've lived in your holiday house as your main home for two years, you can exclude up to $500,000-$250,000 for single taxpayers-from the capital gains tax when you sell the place.
If your vacation house is not your primary residence, mortgage interest and property taxes still can be written off, and you still can add the cost of improvements to your basis. But since the capital gains exclusion is limited to your main home, that benefit is not available when you sell.
Some people used to skirt around that limitation by selling their primary residence and moving into the second home. After living full-time in the former vacation for two or more years, they then could sell the place and qualify for the entire capital gains exclusion.
As of Jan 1, 2009, though, the tax law differentiates between the amount of time the house was used as a vacation home or rental property and the period it was used as a principal residence.
The rules do not apply to vacation homes purchased before Dec. 31, 2008. But after that, the rules distinguish between "non-qualified" periods of rental use and "qualified" use" as a principal residence. The minimum period necessary to qualify as a principal residence - two years out of the five years preceding the sale - still applies, but now you'll have to allocate any gain between periods of qualified and non-qualified uses.
Again, this is complicated stuff, so be certain to consult with a tax professional. Meanwhile, let's move on the tax benefits of renting your vacation property.
Tax Benefits of Renting Out Your Vaction Home
If the house is a pure rental-that is, you do not spend any time there-you should count all rent as income. Count a security deposit as income only is you keep all or part of it because your tenant damaged something or left early. If you collect the first and last month's rent as well as a security deposit, the extra month is considered advance rent and also should be reported.
While you can deduct the cost of improvements to your personal residence but not the cost of repairs, the opposite is true for a rental property - landlords recover the cost of improvements by claiming depreciation and the cost of repairs is deducted from ordinary income.
Other expenses that are deductible include advertising, cleaning, utilities, insurance, commissions, tax return preparation fees and travel expenses. However, the cost of obtaining financing must be amortized over the life of the loan.
Special rules regarding expenses apply if your place is a condominium or cooperative, which is yet another reason to seek professional advice.
A Vacation Home That You Rent Out And Use Personally
If you occupy your home for part of the year and rent it to others for some or all of the rest of the year, you must divide your expenses between personal and rental use based on the number of days for each purpose.
A day of personal use is considered any day the property is occupied by you or someone else who does not pay rent. But if you use the property and rent it for less than 15 days a year, you need not report your rental income. However, while your rental income is tax free, you can't claim any rental expenses, either.
If you use the house more than 14 days or more than 10 percent of the days it is rented, your place is considered "a vacation home used as a residence." As such, if you have a net loss - that is, if your expenses exceed your income - you cannot use the excess expense to offset income from other courses. Instead, you must carry forward your loss to the next year to be treated as rental expenses.
If you use your vacation home for less than 15 days or no more that 10 percent of the number of days it is rented, the IRS looks at it as a "vacation home used as a rental property." Here, too, you should report and pay taxes on the income less your rental expenses. But losses come under more complicated passive and hobby loss rules, so be sure to seek professional counsel.
Vacation Home Write-Off Expenses
One big write-off missed by many first-time landlords miss is start-up expenses. Among other things, you can claim travel costs incurred in investigating potential real estate markets and fees paid for various professional services (other than those paid to actually purchase a property). Even fees paid to attend classes or real estate seminars are deductible. Unfortunately, travel, entertainment and other "fun" expenses don't count.
By the way, you can claim only one vacation home. If you own more than that, you can write off property taxes only on the second house. Which property is your main vacation home is your choice, but only property taxes are deductible for the other one.
About the Author
Lew Sichelman is a nationally syndicated columnist who first started writing about housing in 1969. He has been rated the top housing columnist in the country by the National Association of Realtors as well as by his peers in the National Association of Real Estate Editors.
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