Summer rentals for 2013 have been stronger than they have been in years, and purchases of vacation homes are on the rise after years of a housing slump. There are tax write-offs for owning a second home. What’s more, the vacation home can provide rental opportunities. It’s understandable to think of vacation homes as only in terms of beachfront or lakefront properties. The tax law doesn’t think this way. Vacation homes aren’t limited to waterfront condos or ski chalets; they can include a boat or an RV, as long as the property includes sleeping, cooking, and toilet facilities. Even time shares may qualify for certain tax breaks that go with home ownership.

Reporting Rental Income

Rental income usually is includable in gross income, but can be offset by certain expenses related to the vacation home (explained below). However, there’s one exception that can give you tax-free income. You do not have to report the rent you receive for a rental that is no more than 14 days. Thus, if you rent your beachfront property for 10 days, the rent you receive is tax free.

Deducting Rental Expenses

Three costs related to the ownership of a vacation home can be taken if you itemize deductions. These deductions are allowed without regard to whether you rented the property:

• Real estate taxes paid on a vacation home are deductible; there is no limit.

• Mortgage interest. The same limits for a primary residence apply to a vacation home ($1 million for acquisition debt, plus $100,000 for home equity debt). Caution: For vacation property, points to obtain the mortgage must be deducted ratably over the term of the loan (they can’t be deducted in the year of the home’s purchase like they can with a main home).

• Casualty and theft losses. Each occurrence is reduced by $100, and your total deduction is limited to the excess of 10% of adjusted gross income.

Time of Use Restrictions on Deductibility of Expenses

• If the rental is no more than 14 days—you can’t deduct any maintenance or other costs beyond those allowed for real estate taxes, mortgage interest, and casualty or theft losses.

• If the rental is more than 14 days and your personal use is more than 14 days or 10% of the rental days—you can deduct some additional expenses, such as maintenance, insurance, and depreciation, but only to the extent of rental income. It is unlikely that a time-share owner who uses his property can ever qualify for these added deductions because of the numbers; his or her personal use usually is not more than 14 days or 10% of the rental days.

• If the rental is more than 14 days but personal use is not more than 14 days or 10% of the rental days—you are considered to hold investment property. You can deduct all of your expenses, subject to the passive loss rules. These rules generally limit annual rental losses to the extent of rental income. However, those with adjusted gross income of no more than $100,000 are allowed to claim rental losses each year up to $25,000 if they can show active participation (which includes setting the terms for a rental and arranging for a rental agent).

Exclusive Rental Property

If you purchase property to be used exclusively for for rental purposes, you should report all income and expenses on Schedule E but if you are not actively and materially involved with management of the property, any losses are considered passive and are not deductible against other income; however, they can be carried over to offset rental income in future years. There is no limitation on how many years a disallowed passive loss can be csarried over.

Conclusion

When owning or buying a second home, be sure to factor in the tax breaks and opportunities you can use to minimize the cost of ownership, enjoy rental income, and ultimately reap a profit.

By:  J.K. Lasser

Edited and Posted by Harold Goedde Ph.D. (Accounting and Taxation)