Issue 31: 2016

Insights

Vacation Homes and Tax Planning

A second residence can generate tax benefits — if you plan ahead

Photograph by Andy Ryan

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It’s the summer, and many families will soon be creating treasured memories together at vacation homes. Whether you own a vacation home and rent it out, are looking to purchase or sell a property, or perhaps upgrade to a larger home, here are a few tax rules to consider.  

Mortgage interest deduction

In order to deduct interest, a mortgage loan must be secured by a qualified residence, which could include a vacation home if used up to 14 days per year or 10% of the time it was rented — whichever is greater. For tax purposes, the maximum amount that can be treated as acquisition indebtedness is $1,000,000 or $500,000 if married and filing separately. If the vacation residence is used as security for a mortgage loan but the proceeds of the loan are used for investment purposes, then the interest may be deductible as investment interest without regard for a cap.  

Rental

If you have a vacation home that you use but sometimes rent out, income and expenses related to the rental are treated in the following ways:

1. If you rent your vacation home on a short-term basis — fewer than 15 days — you do not have to pay federal income tax on the rental income. On the other hand, you generally cannot deduct rental related expenses.

If You Seldom Use Your
Vacation Home, It May Not Even Be Considered A Residence For Tax Purposes.

2. If you rent your vacation home for 15 days or more, you are not eligible for this exclusion. All rental income must be reported, but could be offset by certain rental-related expenses. Other expenses, such as mortgage interest and real estate taxes, need to be apportioned to the rental use of the residence and then deducted. Yet, other expenses may be deductible only to the extent of rental income. In some circumstances the excess can be carried forward to succeeding tax years.

If you seldom use your vacation home, it may not even be considered a residence for tax purposes. In that case, expenses in excess of rental income could result in a tax loss that may offset other income, subject to complicated passive activity rules.

Selling a vacation home

When it comes time to sell your vacation home, taxes may be mitigated if you can convert your home to a principal residence or its sale is part of a like-kind exchange (selling one vacation property and acquiring another).


Shutterworx/Getty Images

 

Taxpayers can exclude up to $500,000 ($250,000 for a single taxpayer) of gain from the sale of a home but only if the home is your “principal residence” and other conditions are met.  A special tax rule is aimed at preventing a residence that was formerly a vacation home or rental property from being converted to a principal residence and fully qualifying for the exclusion (however, a partial exclusion may apply).  On the other hand, if you stopped using your residence as a principal residence and it has now become a rental property or vacation home, it could still qualify for the full exclusion, provided other conditions are met.

A like-kind exchange of a vacation home could result in no current tax but is not easily achieved with a vacation home. If the vacation home is used solely for personal use, then it would not qualify for tax deferral. If it is used solely as a rental property, it could qualify. In the case of mixed use, it can be difficult to determine whether it could qualify for like-kind. In that event, the IRS has provided a so-called Safe Harbor rule to assist taxpayers.

Contact your U.S. Trust advisor for more information and your tax advisor to determine whether, and to what extent, you qualify for these benefits.

IMPORTANT INFORMATION

Any information presented about tax considerations affecting client financial transactions or arrangements is not intended as tax advice and should not be relied upon for the purpose of avoiding any tax penalties. Neither U.S. Trust and its representatives nor its advisors provide tax, accounting or legal advice. Clients should review any planned financial transactions or arrangements that may have tax, accounting or legal implications with their personal professional advisors.

Always consult with your independent attorney, tax advisor, investment manager and insurance agent for final recommendations and before changing or implementing any financial, tax or estate planning strategy.

It’s the summer, and many families will soon be creating treasured memories together at vacation homes. Whether you own a vacation home and rent it out, are looking to purchase or sell a property, or perhaps upgrade to a larger home, here are a few tax rules to consider.  

Mortgage interest deduction

In order to deduct interest, a mortgage loan must be secured by a qualified residence, which could include a vacation home if used up to 14 days per year or 10% of the time it was rented — whichever is greater. For tax purposes, the maximum amount that can be treated as acquisition indebtedness is $1,000,000 or $500,000 if married and filing separately. If the vacation residence is used as security for a mortgage loan but the proceeds of the loan are used for investment purposes, then the interest may be deductible as investment interest without regard for a cap.  

Rental

If you have a vacation home that you use but sometimes rent out, income and expenses related to the rental are treated in the following ways:

1. If you rent your vacation home on a short-term basis — fewer than 15 days — you do not have to pay federal income tax on the rental income. On the other hand, you generally cannot deduct rental related expenses.

If You Seldom Use Your
Vacation Home, It May Not Even Be Considered A Residence For Tax Purposes.

2. If you rent your vacation home for 15 days or more, you are not eligible for this exclusion. All rental income must be reported, but could be offset by certain rental-related expenses. Other expenses, such as mortgage interest and real estate taxes, need to be apportioned to the rental use of the residence and then deducted. Yet, other expenses may be deductible only to the extent of rental income. In some circumstances the excess can be carried forward to succeeding tax years.

If you seldom use your vacation home, it may not even be considered a residence for tax purposes. In that case, expenses in excess of rental income could result in a tax loss that may offset other income, subject to complicated passive activity rules.

Selling a vacation home

When it comes time to sell your vacation home, taxes may be mitigated if you can convert your home to a principal residence or its sale is part of a like-kind exchange (selling one vacation property and acquiring another).


Shutterworx/Getty Images

 

Taxpayers can exclude up to $500,000 ($250,000 for a single taxpayer) of gain from the sale of a home but only if the home is your “principal residence” and other conditions are met.  A special tax rule is aimed at preventing a residence that was formerly a vacation home or rental property from being converted to a principal residence and fully qualifying for the exclusion (however, a partial exclusion may apply).  On the other hand, if you stopped using your residence as a principal residence and it has now become a rental property or vacation home, it could still qualify for the full exclusion, provided other conditions are met.

A like-kind exchange of a vacation home could result in no current tax but is not easily achieved with a vacation home. If the vacation home is used solely for personal use, then it would not qualify for tax deferral. If it is used solely as a rental property, it could qualify. In the case of mixed use, it can be difficult to determine whether it could qualify for like-kind. In that event, the IRS has provided a so-called Safe Harbor rule to assist taxpayers.

Contact your U.S. Trust advisor for more information and your tax advisor to determine whether, and to what extent, you qualify for these benefits.

IMPORTANT INFORMATION

Any information presented about tax considerations affecting client financial transactions or arrangements is not intended as tax advice and should not be relied upon for the purpose of avoiding any tax penalties. Neither U.S. Trust and its representatives nor its advisors provide tax, accounting or legal advice. Clients should review any planned financial transactions or arrangements that may have tax, accounting or legal implications with their personal professional advisors.

Always consult with your independent attorney, tax advisor, investment manager and insurance agent for final recommendations and before changing or implementing any financial, tax or estate planning strategy.