Vacation-property taxes are tricky


May 16, 2004

What are the tax rules for income and expenses on vacation homes?

Here are answers to some frequently asked questions:

Can I deduct mortgage interest and property taxes on my vacation home?

Property taxes are deductible even if you don't have rental income. Mortgage interest is deductible on the first $1 million of debt used to purchase, build or improve your principal residence and one vacation home. These deductions are reduced for high-income taxpayers.

I rent my vacation home for several weeks each year. Is the rental income taxable?

The tax treatment of rental income depends on how many days you rent your home and how many days in a year you and your family use it.

When you rent your second home for less than 14 days a year, you don't pay tax on the rental income. Your tax deductions are limited to real estate taxes and mortgage interest. Other rental expenses are not deductible.

When you rent your vacation home for more than 14 days a year, the net rental income (rentals less expenses and depreciation) is included in taxable income.

If the expenses of my vacation home exceed rental income, can I deduct the excess expenses?

After deducting for real estate taxes and mortgage interest, you can deduct additional expenses of a second home, including depreciation, up to the amount of rental income.

If you use your vacation home for personal use less than 14 days (or less than 10 percent of the total rental days, if greater) you may be able to deduct expenses in excess of rental income, provided your adjusted-gross income does not exceed certain limits.

To the extent that rental expenses are not deductible in the year they are incurred, they can be carried forward to future years.

If I sell my vacation home, will the gain be taxable?

Yes. The capital gains exclusion of $250,000 ($500,000 in a joint return) applies only to the sale of your principal residence. Your second home won't qualify unless you live in the home as a principal residence for at least two of the five years before the sale.

If you rent your vacation home, you may be able to defer tax on the sale by purchasing another investment property under a Section 1031 exchange.

Since the tax rules on vacation homes are detailed and complex, you always should consult your accountant or tax adviser about your specific situation.

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