To Rent or Not to Rent
That is the question. Or at least it is if you happen to own a second home or are considering purchasing one. I’ve written about the decision of renting versus buying previously, but in this issue the discussion focuses on the tax advantages of owning, and at least partially renting, a vacation home.
But first, a disclaimer…I’m not an accountant, nor tax or financial advisor, and I make no claims of being one. Instead, I’m a realtor with years of mortgage experience who’s been asked questions on this subject many times. Because tax laws are complicated and change frequently, I’ve sought the advice of my accountant and have researched this topic in order to offer readers some tips on the basics and what to discuss with their own professionals in this area.
In general, owning a home means tax deductions year after year. Owning a second home can mean additional tax deductions, but what you can deduct and how much depends on how the home is used. It’s not surprising that many second-home buyers rent their properties, at least part of the year, to help offset its expenses. But what’s surprising to many who do is that applicable tax rules differ according to the breakdown between personal and rental use of the home. Note that personal use includes use by family members.
If you use the home exclusively for vacations, it’s considered a personal residence and, following established IRS guidelines, you can still deduct mortgage interest and property taxes, just like you do for your primary home.
But if you use your second home as a combination vacation home and rental property, the applicable second-home tax guidelines are determined by how often you use your vacation home, how often you rent it out, and how long it sits empty. In each of these cases, the key consideration is 14 days.
Why 14? There doesn’t seem to be a definitive, universal answer to that question, but suffice it to say, it’s the threshold of sorts that the IRS uses to determine how tax laws apply to second homes.
For instance, the IRS says that if you rent the property for less than 14 days a year, you don’t have to report any rental income and can simply pocket the cash tax-free. Even if you charge $7,500 per week rental, they don’t want to hear about it. On top of that, you’re still allowed to deduct mortgage interest and property taxes.
Where it gets tricky is when you rent the property for more than 14 days a year. If you do, your vacation home will fall under the tax rules for rental properties rather than for personal residence. Consequently, you must report all of the rental income. Rental expenses are an allowable deduction, provided you allocate costs between the time the property is used for personal purposes and the time it is actually rented.
It gets even more complicated as the IRS stipulates that so long as your personal use of the home doesn’t exceed 14 days of the year, or 10% of the total days (whichever is greater) the property is rented in a year at a “fair rental price,” it still considers the classification to be personal use.
For example, assume you rent the house 210 days of the year and vacation there for 21 days, or 10% of the year, it is deemed to be a rental property. Should you decide to add just one more day to your vacation, you’d fall back under the personal residence criteria. Do I see a longer vacation on the horizon for anyone? I think so. Sorry Uncle Sam.
In this case, mortgage interest, property taxes and allowable operating expenses must all be allocated based on the total number of days the house was used. The total number used here would be 231, so the calculation ratio would be 21/231 for personal use and 210/231 for rental. Make sense yet? That’s what I thought.
The bottom line is that regardless of how you use your second home, the amount of deductions you can take for expenses can’t be greater than the total amount collected in rent. If you have do deductions, they must be itemized on your tax returns.
In order to take the maximum amount of deductions, you should keep accurate records of mortgage interest paid, receipts, cancelled checks and other proof of payment for expenses incurred as a result of owning the property.
Should you find this information pertinent to your personal situation, hopefully it’s obvious by now that the most important tip resulting from this column is to seek the professional advice of a CPA or financial advisor. The potential benefits certainly exist. Just don’t assume you’ll get it right on your own. Good luck!
Chris is a regular contributor to Letters from CAMP Rehoboth and can be reached at email@example.com.
This column is not intended to render financial, tax, or other professional advice on specific facts or matters. If you have questions, it is important to consult your accountant or tax advisor before making financial decisions. CAMP Rehoboth and Chris Beagle assume no liability whatsoever in connection with its use.