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Deducting your home away from home

vacation_8Image by Lisa{santacrewsgirl} via Flickr

It's vacation time! Maybe you are thinking this is the time to pull the trigger on that vacation home you've had your eye on. Will your tax return help you pay for it?

Maybe. 

The tax law permits you to deduct the interest on debt used to acquire a vacation home as home mortgage interest, as long as you claim interest on no more than two houses, and as long as you deduct the interest on no more than $1 million in home acquisition debt. You can also claim deductions for the property taxes on your vacation home.

If you rent out your vacation home 14 days or less, that's all the deductions you get -- but in that case, you also don't have to pick up any rental income on your 1040 either. 

If you rent your vacation home out for more than 14 days -- more deductions could be available, depending on how much you use the home and how many days you have tenants. The additional deductions come from operating expenses for the home -- utilities, association dues, cleaning and the like -- and from depreciating the cost of the building. You have to allocate the costs between personal and rental use of the home based on days used by you and days used by renters. If you use the house for 14 days and rent it for 56 days, you could potentially deduct 56/70 (80 percent) of the operating expenses.  

But now it gets complicated.  If you use the house more than the greater of:

  • 10 percent of the total days the property is used, or
  • 14 days,

the tax law doesn't permit deductions of operating expenses to reduce your income from the property to below zero. You have to apply the interest and property tax deductions attributable to your rental income against the rental income before can deduct any operating expenses on your way to zero. 

For example, you rent out your Minnesota cabin for 60 days and use it for 20 days. You earn $8,000 in rent. You pay $4,000 in interest and $2,000 in property taxes on the house. You have operating association dues and utilities of $3,600 and depreciation of $4,800 (it's computed on a 27.5-year life).  

First, you split your expenses between the 25 percent personal use and the 75% rental use.  That leaves you with $3,000 in interest and $1,500 in property taxes to apply against your $8,000 rental income, leaving you with $3,500 before operating expenses and depreciation. The 75 percent of the $3,600 operating expenses attributable to rental income is $2,700. That would seem to leave you with $800 of income before depreciation. Because your personal use is more than 10 percent of the total use, and more than 14 days, you can only take enough depreciation to take the $800 income down to zero. The remaining $4,000 depreciation would just carry forward in case you ever have enough rental income to use it.

Even if you use the house so little that this limit doesn't apply, the "passive loss" rules might limit your use of the losses, unless you have other "passive" income. In any case, you need to keep good records, including records of personal and business use.

So while your 1040 won't pay for your vacation home, you might as well take the deductions that you can.  Moving deductions from your schedule A to your Schedule E will usually move money from the IRS to your bank account, and that's a good thing. 

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