June 17, 2016

Buying a Vacation Home? A Guide to What’s Deductible

Before you buy that dream vacation home, consider these helpful tax tips to give you the lay of the land.
Ann Brownholtz, CPA

You’ve spent years vacationing on the Delmarva peninsula, and now you’ve decided to own a vacation home instead of renting each year. It’s the perfect place for you and your family to relax and spend time together, but you may be asking yourself—can I really afford this? Maybe you hope that the break you’ll get on taxes will help to make your dream vacation home a reality.

There are multiple possible scenarios each with their own set of tax issues when owning a second home, and in full disclosure, the tax ramifications can become very complicated. For now, let’s go over a few basic concepts to give you the lay of the land.

No Rental of the Vacation Home

Perhaps you intend for your vacation home to be devoted only to your personal use for your family and friends. Since you don’t plan to rent it out, no rental income will be received. In this scenario, you will be able to deduct real estate taxes and, for a second home, mortgage interest expense. Keep in mind that the mortgage interest is considered qualified residence interest and is subject to the overall $1,000,000 ($500,000 for a married couple filing separate) limitation on the mortgage interest deduction. See the 2015 Publication 936 for more information.

Rental with Personal Use

Suppose you decide to rent your beach house for the months of July and August, and reserve it for your own use the remainder of the year. You and your family end up using it for most of June and a few days off-season.  You will need to report the rental income on your tax return, and will be able to take a deduction for part of your expenses. The expenses will need to be divided between the rental period (to be offset against rental income) and the personal period. Some of the prorated expenses during personal use, like real estate tax and mortgage interest, may be deductible as well. Additionally, you will be entitled to take a depreciation deduction based on the cost of the home. To give you an idea of what that might look like below, see the example below. The IRS also provides information and examples along with a worksheet for allocating expenses between rental and personal purposes. IRS Pub 527 Worksheet 5-1

Keep in mind that there are limitations on the overall amount that may be deducted. Generally, any excess of expenses over the rental income cannot be used to offset income from other sources, but must be carried forward to the next year and treated as rental expense for the property.

Other Situations to Consider

Maybe you plan on renting the house with minimal personal use. If your personal use is less than 15 days (or 10% of days rented) it may be disregarded in terms of limiting the expense deduction. One cautionary note—care needs to be taken in determining what constitutes personal use. Use of the home by a family member, even an extended one, may be considered personal use. Also keep in mind that your losses will be subject to the passive activity rules, and may be limited.

There are other scenarios that call for careful planning. 

  • Converting a rental to personal use is a situation that may create unintended tax consequences down the road, especially upon sale. 
  • Rental to family members needs to be looked at in terms of what is a fair market rental rate.
  • Maybe you plan to purchase a multi-family dwelling, and will use part for personal use and rent the other part. 
  • Another common situation is personal use with de minimus rental – you use the home as your personal vacation home except for a one-week rental. In this case, you are entitled to disregard the rental income because it is less than the 15-day guideline.

Ask Before You Buy

Vacation homes can create complicated tax issues along with blissful family memories.  As always, it’s best to call us or your tax professional and let us know your plans ahead of the purchase date to avoid any unnecessary tax surprises.

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Ann Brownholtz, CPA

Ann is known as the go-to CPA for preparing the most difficult and complex tax returns. She is the consummate tax professional—an expert on the tax code and all its ramifications for individuals, trusts, real estate and all other partnerships.