You've probably heard that owning a second home provides some tax relief—and, it can. There are some special tax rules and regulations that apply to second properties, however, and they can be a little confusing. Hang in there, we'll try to make this as clear as possible.
To figure out what type of tax breaks you might get as related to your vacation home, you need to know how you'll use the property, and how the Internal Revenue Service will categorize it.
Your vacation home will be considered a residence if you use it for personal purposes at least part of the year. If you rent it all year, it's considered to be a rental or investment property.
The first rule to remember is that you can't deduct the mortgage interest on your vacation home as home mortgage interest on line 10 of Schedule A if it's not considered to be a residence. Refer to the IRS Web site at www.irs.gov to select and print a copy of Schedule A.
Vacation homes come in many packages. Your vacation home could be a house, a condo, a cabin, or a duplex. It also could be a boat or a recreational vehicle. To qualify for a tax deduction, your vacation home needs to have a bathroom, kitchen, and a place to sleep. It's a good idea to pay a visit to your accountant before you buy a vacation home. Ask her about tax advantages for rental properties and residences, and have her run pro forma returns under different scenarios to see how your income tax return may be affected.
That doesn't mean, however, that you can't rent a vacation home and still have it be considered a residence. It's all a matter of timing.
The IRS says in order to have your vacation home qualify as a residence, you need to spend at least 14 days there, or 10 percent of the amount of time that the property is rented.
Let's say that you own a home on a lake, very close to some good ski areas. The location makes your home attractive to skiers and snowmobilers in the winter, and to families and others who enjoy the lake, hiking, and so forth in the summer. There's a big demand for these properties, and you have no trouble renting your home for 210 days out of the year.
You might think the rental income is great, but if you don't use the house for at least 21 days, the IRS will consider the home to be a rental property and you won't be able to deduct your mortgage or real estate taxes entirely on Schedule A. Part of the mortgage interest will need to be declared against the rental income on Schedule E of your tax return. Refer to the IRS Web site at www.irs.gov to select and print a copy of Schedule E.
On the other hand, if you own a vacation home and rent it for less than two weeks, you get a tax break because you don't need to report the rental income on your tax return. All that rental income is, essentially, tax free.
If your property is considered a residence, but you rent it for more than two weeks a year, you'll need to report the rental income. You'll also be able to take advantage of some allowable tax deductions, but since it's a vacation home, you can't have more expenses than income. You can come out to zero, but the IRS doesn't permit you to take a tax loss on a vacation home.
The income and deductions offset each other when you rent a vacation home for more than two weeks. Deductions include the following:
Real estate taxes
Supplies and miscellaneous expenses