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How are vacation homes taxed?

July 18, 2013

Dina M. Ouellette, CPA
Tax Director

Vacation homes offer owners many tax breaks similar to those for primary residences.  Vacation homes also offer owners the opportunity to earn tax-advantaged and even tax-free income from a certain level of rental income.  The value of vacation homes are also on the rise again, offering an investment side to ownership that can ultimately be realized at a beneficial long-term capital gains rate.

In addition to property taxes, homeowners can deduct mortgage interest they pay on up to $1.1 million ($550,000 if married filing separately) of "acquisition indebtedness" incurred to buy their primary residence and one additional residence.  If their total mortgage indebtedness exceeds $1.1 million, they can still deduct the interest they pay on their first $1.1 million.  If one mortgage carries a substantially higher rate than the second, it makes sense to deduct the higher interest first to maximize deductions.

Vacation homeowners don't need to buy an actual house (or even a condominium) to take advantage of second-home mortgage interest deductions.  They can deduct interest they pay on a loan secured by a timeshare, yacht or motor home as long as it includes sleeping, cooking and toilet facilities.  There are, however, different rules when calculating the alternative minimum tax.

Capital gain on vacation properties. Gains from selling a vacation home are generally taxed as long-term capital gains on Schedule D.  As with a primary residence, basis includes the property's contract price, non-deductible closing costs (title insurance and fees, surveys and recording fees, transfer taxes, etc.), and improvements.  "Adjusted proceeds" include the property's sale price minus expenses of sale (real estate commissions, title fees, etc.).

For federal tax purposes, the maximum tax on capital gains is now 20 percent, with an additional 3.8 percent net investment tax depending upon income level.  Unfortunately, there's no exclusion that applies when selling a vacation home (as there is up to $500,000 (married filing jointly)/$250,000 (married filing single) for a primary residence).

Vacation home rentals. Many vacation homeowners rent those homes to draw income and help finance the cost of owning the home.  These rentals are taxed under one of three sets of rules depending on how long the homeowner rents the property.

  • Income from rentals totaling not more than 14 days per year is non-taxable.
  • Income from rentals totaling more than 14 days per year is taxable and is generally reported on Schedule E of Form 1040.  Homeowners who rent their properties for more than 14 days can deduct a portion of their mortgage interest, property taxes, maintenance, utilities and other expenses to offset that income.  Those deductions are dependent on how many days they use the residence personally versus how many days they rent it.
  • Owners who use their home personally for less than 14 days and less than 10% of the total rental days can treat the property as true "rental" property, which entitles them to a greater number of deductions.  There can be some additional limitations with the passive activity loss rules.

 If you have additional questions, please contact Dina Ouellette at douellette@blumshapiro.com.

 

Disclaimer: Under U.S. Treasury Department guidelines, we hereby inform you that (1) any tax advice contained in this communication is not intended or written to be used, and cannot be used by you, for the purpose of avoiding penalties that may be imposed on you by the Internal Revenue Service (or state and local or other tax authorities), and (2) no part of any tax advice contained in this communication is intended to be used, and cannot be used, by any party to promote, market or recommend any transaction or tax-related matter(s) addressed herein without the express and written consent of Blum, Shapiro & Company, P.C.

 

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