Current tax laws
offer several tax breaks that can help make second-home ownership more
affordable. Different tax rules apply depending on how you use the property, for
either personal or rental use, or a combination of the two.
Personal Use
As long as you use
the property as a second home – and not as a rental – you can deduct mortgage
interest the same way you would for your primary home. You can deduct up to
100% of the interest you pay on up to $1.1 million of debt that is secured by
your first and second homes (that's the total amount – it's not $1.1 million
for each home). You can also deduct property taxes on your second
home and, for that matter, as many properties as you own. Like a primary
residence, however, you generally can't write off any of the costs associated
with utilities, upkeep or insurance (there are exceptions to this; for example,
you may be able to claim a home office deduction if part of your home
is used for business purposes).
Rental Use – The
14-Day or 10% Rule
The tax rules are
quite a bit more complicated if you rent out the property. Different rules
apply, depending on how many days a year you use the home for personal versus
rental use. There are three categories into which you may fall:
1. You Rent Out the
Property for 14 Days or Less.
Your second home can
be rented to another party for up to two weeks (14 nights) each year without
that income begin reported to the IRS. Even if you rent it out for $10,000 a
night, you don't have to report the rental income as long as the home was not rented
out for more than 14 days. The house is still considered a personal residence,
so you can deduct mortgage interest and property taxes under the
standard second-home rules.
2. You Rent Out the
Property for 15 Days or More, and Use It for Less Than 14 Days or 10% of Days
the Home Was Rented.
This property is
considered a rental property, and the rental activities are viewed as a
business. If your second home is rented out for more than 14 days, all rental
income must be reported to the IRS. You can deduct rental expenses (including
mortgage interest, property taxes, insurance premiums, fees paid to property
managers, utilities, and 50% of depreciation), but you have to factor in the
amount of time the property is used for personal use versus rental use. And, as
a rental property, up to $25,000 in losses might be deductible each year.
Fix-up days don’t count as personal use, so you can spend more than 14 days at
the property as long as it is for maintenance purposes. You should be able to
document the maintenance activities, however, with receipts to prove you
weren't using the property for leisure purposes on those days.
3. You Use the
Property for More Than 14 Days or 10% of the Total Days the Home Was Rented.
If you use the
property for more than 14 days, or more than 10% of the number of days it is
rented (whichever is greater), the property is considered a personal residence
and the rental loss cannot be deducted. If a member of your family uses the
property (including your spouse, siblings, parents, grandparents, children, and
grandchildren), those days count as personal days unless you are collecting a
fair rental price.
Selling Your Second
Home
Tax laws allow you to
take up to $500,000 profit ($250,000 if you are unmarried) tax free on the sale
of your primary residence. This primary-home sale exclusion does not apply if
you sell your second home: If you sell a house that is not your primary
residence, you may have to pay the usual capital gains tax. If you make the
second home your primary residence for at least two years before you sell it,
however, you may be able to reap some tax benefits, but it's not as easy as it
used to be.
Prior to Jan. 1,
2009, you could move into your second home, make it your primary residence for
two years, sell it, and take advantage of the primary-home sale exclusion. Now,
as a result of new laws associated with the Housing and
Economic Recovery Act of 2008, you can still make your second
home a primary home before you sell it, but you'll owe taxes for the period of
time that the property was a second home after Jan. 1, 2009. The IRS now uses a
ratio of the years you occupied the home as a primary residence versus the
years the home was used as a rental (or other-than primary residence) to
calculate the amount of capital gain that will be excluded from the sale.
For example, the
Smiths purchased a second home in 2004. They continued to use it as a rental
home during 2009 and 2010, and then used the home as a primary residence during
2011 and 2012. Only 50% of the capital gains from the sale of the home will be
tax free (up to the $500,000 exclusion) since the home was a primary residence
for only 50% of the time after Jan. 1 2009.
1031 Exchanges
A 1031 exchange,
also known as a like-kind exchange or tax-deferred exchange, is a transaction where
a seller swaps a rental or investment property for another rental or investment
property of equal or greater value, on a tax-deferred basis. The advantage is
that the seller may be able to avoid paying capital gains tax on the exchange.
A property must be considered a rental property (and not a personal residence)
to qualify for a 1031 exchange. This means that you must rent out the property
for 15 days or more, and use it for less than 14 days or 10% of days the home
was rented.
Since tax laws are complicated and do
change, owners and potential buyers should consult with a qualified real-estate
tax specialist to gain a full understanding of tax implications and laws, and
to determine the most favorable ownership strategy.
Michelle Mustain
843-338-4898
