Tax advantages of second homes

What are the tax breaks you receive when buying a Lake of the Ozarks home or condo? If done correctly, you can ensure that your weekend retreat becomes a source of equity, maybe a source of income, a shelter from taxation and a valuable inheritance for your children.

Just like your primary home, a second home gives you a deduction depending on how you financed the purchase, regardless of residency. The easiest way to explain this is to give an example. If the principal and interest portion of your mortgage and property taxes amount to $1,000 a month (P&I payment + your annual tax bill/12), the federal government’s subsidy amounts to $270, assuming you’re in the 27 percent tax bracket. Thus, the tax-savings effectively reduces the out-of-pocket cost to $730 a month ($1000 – $270 = $730.) Not a bad deal at all. If you are using an interest only payment, you can maximize your deduction as the whole payment is deductible. While you can deduct the interest on a second home, it can be only on one second home. You do get to pick which second home counts, not the first one you purchased.

To help pay the considerable expense of owning a vacation home at the Lake of the Ozarks, many owners rent out their places part of the time. Besides extra cash to help with the monthly payments, renting also has some extra tax benefits as well. I don¿t know anyone that doesn¿t pay taxes, so one should always look at investments after taxes, and especially when looking at real estate, because real estate has some unique and quite generous tax breaks. Here’s an informative publication IRS Tax Topic(HTML) or IRS Form 527 PDF which also covers vacation and second homes.

Most vacation home owners can qualify for the same tax breaks as landlords who own normal rental properties. But to qualify for the breaks, you’ll need to carefully watch how much personal use you make of your vacation home each year. In some cases, exceeding the prescribed limits by a single day can cost you thousands of dollars in deductions. You’ll also need to crunch some numbers to see whether you’re really better off trying to qualify for the rental tax breaks. Upper-income owners who classify their vacation home as a rental property usually wind up with fewer deductions than they would if they simply treated it as a second home.

As a second home, most people can write off all their mortgage interest and property taxes just as they can on their principal residence. The law allows homeowners to deduct interest on the first $1 million in mortgage debt used to acquire a first and second home. How much more of a tax shelter your vacation home can be depends on how much you rent it out, how much personal use you make of the place, how much rent you collect and who you rent your Lake property to.

If you rent out your home/condo no more than a 14 days a year, you get a simple break. Any rental income you collect is tax-free, and that is always good news! You don’t even have to report the income on your tax return. Besides benefiting from the tax-exemption, you’ll be eligible to deduct mortgage interest and property taxes on your second home. But you won’t be eligible for any additional deductions for your rental-related expenses.

If you rent out your vacation home more than 14 days a year, all of your rental income is subject to tax including the first 14 days of rent. But you’re allowed to write off rental-related expenses such as utilities, maintenance and depreciation up to certain limits. How much you can deduct depends partly on how much personal use you make of the place. Rental expenses can be deducted only to the extent of your rental income if you and your family personally use the place more than 14 days a year or 10 percent of the number of days it’s rented out, whichever is greater. The deductions have to be apportioned between personal use and rental use. So, say you used the property for 15 days and rented it for 200 days. Every deduction would be apportioned between personal use and rental use. You would be able to take 200/215 (days rented over total days used, they don’t need to equal 365 days) times each deduction to determine what you can claim as a deduction related to the rental activity. The mortgage interest and real-estate taxes that are allocated to personal use would be claimed as itemized deductions on your Schedule A with the remainder claimed as a deduction against the rental income on Schedule E for Form 1040. But if you keep your personal use within those limits, your vacation home would qualify as a rental property. That status makes most owners eligible to write off much more of their rental expenses as much as $25,000 in excess of rental income. This extra $25,000 deduction allowance, however, is reduced if your adjusted gross income exceeds $214,050 (for married filers) and is phased out completely at $336,550. These numbers can and do change, talk to your tax professional. Vacation homes do not have all the tax benefits available for principal residences. For instance, “points” paid to a lender to obtain mortgage financing on a vacation home aren’t immediately deductible. These one-time fees can usually be deducted in full when buying a principal residence. But for vacation homes, deductions for points must be spread over the life of the loan. Points have not been as prevalent with the low interest rates, but as they creep up, we will start seeing them again.

You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.