Whatever the location, size, or value of a second home, certain tax advantages are built in. However, your opportunity to benefit from them depends on how you use the property.
Both property taxes and mortgage interest are as deductible for a second home as they are for your primary residence — and are subject to the same limitations. If you file a joint return, you cannot deduct interest on more than $1 million of acquisition debt ($500,000 for married persons filing separately) on one or two homes.
Two tax advantages of homeownership are not available for a second home — the immediate deduction of mortgage points when purchasing and the capital gain exemption when selling. Both tax breaks require the home to be your “principal residence.” However, you can deduct the points on your second home’s mortgage over the loan’s term.
More tax advantages become available if you forgo some of your personal use in favor of renting out your second home for part of the year. But there may be drawbacks as well.
If you rent out your home for 14 or fewer days during the year, you do not have to report rental income on your tax return, regardless of the amount, and there is no effect on your mortgage interest deduction. But you cannot deduct any rental expenses.
If you rent out your property for more than 14 days during the year, all rental income becomes taxable from day one. However, rental-related ownership expenses — including depreciation, maintenance, and utilities — become tax deductible. Your personal use of the second home affects the deductible amount. When personal use is more than 14 days (or 10% of the number of days your home is rented, whichever is greater), the maximum deduction is 100% of the rental income. Note that allowing relatives to use your vacation home usually counts as personal use, regardless of how much they pay for the privilege. And, if a friend rents your home for less than the fair market rate, that also counts as personal use.
If your vacation home qualifies as a rental property (i.e., personal use doesn’t exceed the allowable limits), a deduction is allowed only for mortgage interest allocated to rental use. That could be important. If you were to rent your second home during July only, for example, then only 1/12 of your interest expense would be deductible.
What if your rental expenses exceed the rent you collect? Only an “active” investor can deduct rental losses. If you actively participate in managing the rentals and maintaining the property, you can apply up to $25,000 of losses each year against your regular income. This loss deduction is phased out for taxpayers with adjusted gross income between $100,000 and $150,000. But, if you hire a manager, you become a passive investor and can use rental expenses to offset only rental income. However, you can carry any excess deductions forward to future tax years.
Your use determines the tax treatment of a second home. Before you decide to rent your second home for more than 14 days a year, carefully weigh the benefits and disadvantages.
Deductible Yacht and Motor Home Financing
Your second home doesn’t have to sit on a fixed foundation to qualify for tax advantages.
According to the IRS, a facility qualifies as a residence if it has sleeping, cooking, and bathroom accommodations. Therefore, your yacht or smaller boat can be a second home. So can a motorhome of any size or value.
Provided the boat or motorhome secures the purchase loan, your mortgage interest is as deductible as it would be on a more conventional second home. The same $1 million limit on total debt to buy or improve your residences also applies.
For more help with taxes questions, connect with our Milwaukee CPA firm at 414-325-2040. Our team can help you with all your tax issues, large and small. We also can help with any real estate accounting questions you might have.