Financial Learning Center
- Making Decisions
- How Will You Use the Property?
- Uncle Sam: Your Partner in the Deal
- Why Pay Full Price for Part-Time Use?
Many vacation home owners were looking for a tax shelter that they could themselves enjoy. Uncle Sam got wind of this and came up with vacation home tax rules that make even the most seasoned tax professional dizzy.
SUGGESTION: If you plan on renting the property, hire an accountant to prepare your taxes. It is important that you take advantage of all the tax benefits that you are entitled to while complying with the law.
How income and expenses are treated for tax purposes:
A. If the property is rented for fewer than 15 days during the year, no deductions attributable to the rental property are allowable and no income is included in gross income.
B. Where rental use exceeds 14 days - if you use the home for more than the greater of 14 days or 10% of rental days:
- Rental expense deductions cannot exceed rental income and must be deducted in the following order: mortgage interest; real estate taxes; casualty losses; insurance; repairs; utilities; and depreciation. Once rental income is reduced to zero, unused deductions are carried forward to the next year, except for remaining mortgage interest, real estate taxes, and casualty losses which can be deducted on Schedule A.
- Mortgage interest and real estate taxes must be allocated proportionately to rental and personal use. The method described typically yields the largest deduction based upon the property usage.
Call your tax professional to clarify anything you don't understand.
SUGGESTION: If you have equity in your principal residence, consider financing the vacation home through a home equity loan from your principal residence. This allows for more of your other rental expenses to be deducted against rental income.
SUGGESTION: Remember that mortgage interest is tax-deductible up to $750,000 of combined indebtedness on up to two properties.
Each year the tax treatment of the vacation home can change. In one year you can use it exclusively and the next year you can rent it out part of the year and use it for yourself part of the year. Whichever way the property is used is the way you treat it on that year's tax return.
More Tax Forms
In order to report the rental activity in a mixed personal use or primary rental property, the IRS requires that you file a few more tax forms to include with your Form 1040. Here is a summary of some of the forms you may be required to file and their purpose:
Schedule E—Supplemental Income and Loss
Used to report rental income and expenses for the tax year.
Form 4562—Depreciation and Amortization
Used to report depreciation expenses claimed on the rental property for the tax year.
Form 8582—Passive Activity Loss Limitations
Used to compute the amount of passive activity losses allowed for the tax year, including the cumulative amount of suspended losses that are carried forward.
mount of suspended losses that are carried forward.
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