Do you own a second home at the beach, in the mountains, or some other getaway location, or are you thinking about buying one? If so, then you may have thought about the possibility of renting it out. Though many people would never consider inviting renters into their vacation home, preferring to keep it for themselves and their family, doing so can offset some of the expenses related to the property, and you may even reap a tax benefit at the same time. Whichever route you choose to go, knowing all of the applicable tax rules regarding designated second homes helps you get the maximum financial benefit out of your asset, and keeps you from making tax filing errors.
If You Don’t Rent Your Property - Depending upon your individual tax situation, a designated second home’s acquisition mortgage interest may be able to be included as an itemized deduction. However, there is a limit on the amount of acquisition debt for a taxpayer’s main residence and one additional home for which the interest is deductible. For a primary residence and second home acquired before December 16, 2017 that limit is $1,000,000 ($500,000 if filing married separate). After December 15, 2017 the limit is reduced to $750,000 (except that debt incurred before December 16, 2017 still falls under the $1,000,000 limit).
Real property taxes on your main and any number of additional homes are also deductible if you itemize deductions when figuring your regular tax, but not for the alternative minimum tax (AMT). However, even though itemized taxes include property tax, state income tax, and certain other taxes, the total amount allowed per year is limited to $10,000 ($5,000 if you are married and file a separate return from your spouse), so the deduction for some of your taxes may be limited.
If You Rent Your Property - The tax ramifications of renting out your designated second home are largely dependent upon the amount of time that it is rented out during the year: (1) fewer than 15 days, (2) 15 days or more and your personal use is 10% or less and (3) 15 days or more and your personal use is more than 10%.
If You Sell Your Vacation Home - Even if you use your vacation home to generate rental income, it is still considered to be a property for your personal use, and that means that once you sell it you are subject to taxation on any gains you realize. By contrast, if the sale results in a loss, you are not permitted to deduct any losses – at least not in the examples we’ve provided above. In some cases, a loss on a property can be broken down between the personal, nondeductible use and the business rental portion, which would be deductible.
If You Sell Your Home - When you sell your primary home, you are able to take advantage of what is known as the home gain exclusion, but this is not true of designated second homes. The gain from the sale of a second home is taxable, but eligible for favorable capital gains tax rates in most cases. The only exception to this rule is when the taxpayer has occupied the second home as their primary residence for at least two of the five years immediately before the sale takes place. At no time during that two-year period can the home have been rented. When this is the case and the taxpayer hasn’t applied the home gain exclusion on the sale of another property in the previous two years, the taxpayer is able to take the exclusion. Doing so would allow married homeowners (where both qualify) to exclude from their income up to $500,000 of the home’s gain and single homeowners to exclude home sale gain of up to $250,000, except for depreciation of the home that has previously been deducted.
Other Issues - There are certain situations involving designated second homes that are particularly complex, such as homes that are converted from an investment property to a primary residence, or when they were acquired by tax-deferred exchange. In these instances, it is essential that you consult with this office in order to ensure that all appropriate planning is done to provide you with the ability to gain the most benefit.
If you rent out your property and provide additional services such as maid service, or rent it out for short-term stays, the IRS may view that activity as a business operation rather than a rental. When this is the case the tax ramifications are entirely different. Because of this and many other complicating factors and exceptions it would be appropriate to contact this office to review the tax impact of all of your real estate transactions.