What You Need to Know About Owning a Second Home
Owning a second home is a dream for some, and a source of income for others. With the summer vacation season approaching, it is important that you have a firm grasp of how rental income is (or is not) taxed, what write-offs are available to you, and how your personal use of the property will impact your ability to get tax benefits from your property.
If you rent your property out, the amount of time that it is rented compared to the amount of time that it is occupied for personal use are integral questions. The Internal Revenue Service outlines three different scenarios and corresponding rules:
Properties that are rented for fewer than 15 days during the year and reserved for personal use for the balance of the year are not considered rental properties. There is no tax liability for this short-term rental period, making it very appealing for owners to make their homes available while they are personally away for vacation, or to take advantage of one-time events such as sporting events or major cultural events that attract short-term visitors. If you do take advantage of this type of situation, the income is not taxable, but you will still be able to itemize any interest and taxes paid on your home, but not able to write off any of the expenses you incur related to the short-term rental, i.e., fees, cleaning charges, utilities, or agent fees.
If you use your property yourself for no more than 15 days (or 10% of the time that it is rented out), and the period that it is rented out totals at least 15 days, then the property is deemed both a second home and a rental property. In this case, whatever percent of time you use it personally you are able to take that percentage of the interest and taxes on the home as an itemized deduction on your personal income tax return. The balance of the taxes and interest, insurance, utilities, and allowable depreciation can be written off as rental expenses, as well as any costs directly related to renting it out. When all is said and done, if the amount you take in for rent comes to less than what your expenses are, you can write it off as a loss up to $25,000 per year as long as your adjusted gross income (AGI) is $100,000 or less. For those with an AGI of between $100,000 and $150,000 that loss threshold is phased out, and those whose AGI is over $150,000 cannot deduct their losses. They can, however, carry them forward until there is rental profit, gains from other passive activities, or the property is sold.
If you enjoy a significant amount of time in your second home while also renting it out for a minimum of 15 days, you lose your ability to take a rental-related tax loss. To calculate your tax liability for the property, start by determining the percentage of time that it is rented, then reduce that income by the same percentage of the taxes and interest that you pay. If you’re still in the black, you can further deduct direct rental expenses, as well as the same percentage again of expenses like insurance, repair bills, and utilities. If you are still on the plus side, there are some limited depreciation deductions available, and any profit that remains can be taxed. You still have the opportunity to deduct prorated interest and taxes based on the percentage of time that you use the property personally as an itemized deduction.
Second-home owners who are considering selling their property need to be aware that they will be fully taxed on any gains that they realize. Not only are losses not deductible, but the home-gain exclusion that is generally available when you make a profit on the sale of your primary home does not apply to a second home. The only way around this rule is for you to live in the house as a primary residence for two out of five years prior to the sale. Any rentals during that period would eliminate the opportunity to use the exclusion, as would having used it for another property within two years.
This information simply scratches the surface of what happens when you own and rent a second home. There are plenty of other potential complexities that must be taken into account to be sure that you’re in compliance and taking advantage of every tax opportunity. To be sure that you’re making the most of your investment, contact an experienced tax professional today.
Jon Osborn is a tax preparer based in San Dimas, California. His company, Steward Financial Services, offers a broad range of tax preparation, accounting and business consulting for small businesses. He loves to work with clients who are looking for answers to complex tax and business planning issues. He has owned several small businesses and worked with over one hundred small business owners. He helps his individual and business tax clients find the best ways to spend their money in order to minimize IRS tax. Small businesses looking to grow, sell or just increase cash flow are one of Jon's specialties.
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