Vacation Home Survival Guide
Andrew Beattie
The American Dream has undergone a fair amount of change over the last 50 years. Sometime after cars and televisions became a regular part of even the lowest income earner's life, it became fashionable to buy a second home--a vacation home. These are the cottages on the lakeside, the cabins in the mountains and the huts on the beach that sit empty 90% of the year while their owners are banking time for the next vacation--and footing the bill for the mortgage and property taxes.
There is, of course, an alternative to letting your cottage molder during the downtime. You can rent it out to other people looking to enjoy some time away from work.
Buying A Second Home
Keeping a primary residence is an enormous financial decision. Keeping a second home is a step up in magnitude because a second home has all the costs (often more) of your first home without the easy write-offs from the IRS. By and large, second homes are often a terrible financial burden rather than a good investment.
One of the litmus tests of whether you should have a second property is whether you can handle an all-cash purchase. This will help you to avoid passive losses because your mortgage payments will be nonexistent.
If you are set on getting a vacation home but don't have the capital for an all-cash purchase, do not take a second mortgage on your home. The IRS has closed the loophole where a person could use a second mortgage to purchase a separate investment property while still deducting his or her mortgage from taxes.
If you take a mortgage on your primary residence to buy a second home, you will not be allowed to deduct the payments as personal mortgage interest. If you intend to borrow for a second home, you will have to settle for another mortgage that is not tax-deductible. Again, it is probably best to hold off until you have enough capital to buy the property outright.
As It Stands
Current tax rules surrounding second homes, vacation homes and investment-class second homes have changed more frequently than those of primary residences. As of now, if you currently own a second home for personal use, you are allowed to rent it, or your primary residence, to another party for up to two weeks (14 nights) without reporting any of the income.
On the flip side, a second home is considered an investment property if you spend less than two weeks in it and then attempt to rent it the rest of the time. It is important to remember that, with the advent of resorts and such, the demand for a cabin in the woods may come only at the peak times--the same period of time you would probably want to use the property.
Although taxes for investment properties have been traditionally softer than for other types of investing, second homes seem to be a gray spot for the IRS. All rental losses are passive losses or hobby losses, and these can only be used against--written-off against--income from other passive activities like other rentals, a private partnership you don't help operate or an S-corporation.
Passive losses that you can't use are carried forward until you sell the vacation home. When you sell the property, the past losses can be used to offset any gains, and, if you have more passive loss write-offs afterward, you can claim them against regular income.
You can, however, deduct up to $25,000 a year, if your adjusted gross income is less than $100,000, or you actively participate in the management of the property. This tax break vanishes at $150,000 adjusted gross income. If you are between $100,000 and $150,000, you qualify for half the deduction. This seems foolish, as most of the people who can afford to buy a second home will have an adjusted gross income far above these numbers.
Still, the real challenge is in the second condition. You can use the yearly deduction if you or your spouse want to become a qualified real estate professional and actively manage the property that is posting the passive losses. Be warned, however, the IRS is not likely to believe that you hold a full-time job and moonlight as a property manager. You will need a detailed journal on why, when, where and what you are doing as a property manager in order to prove your case.
Andrew Beattie
The American Dream has undergone a fair amount of change over the last 50 years. Sometime after cars and televisions became a regular part of even the lowest income earner's life, it became fashionable to buy a second home--a vacation home. These are the cottages on the lakeside, the cabins in the mountains and the huts on the beach that sit empty 90% of the year while their owners are banking time for the next vacation--and footing the bill for the mortgage and property taxes.
There is, of course, an alternative to letting your cottage molder during the downtime. You can rent it out to other people looking to enjoy some time away from work.
Buying A Second Home
Keeping a primary residence is an enormous financial decision. Keeping a second home is a step up in magnitude because a second home has all the costs (often more) of your first home without the easy write-offs from the IRS. By and large, second homes are often a terrible financial burden rather than a good investment.
One of the litmus tests of whether you should have a second property is whether you can handle an all-cash purchase. This will help you to avoid passive losses because your mortgage payments will be nonexistent.
If you are set on getting a vacation home but don't have the capital for an all-cash purchase, do not take a second mortgage on your home. The IRS has closed the loophole where a person could use a second mortgage to purchase a separate investment property while still deducting his or her mortgage from taxes.
If you take a mortgage on your primary residence to buy a second home, you will not be allowed to deduct the payments as personal mortgage interest. If you intend to borrow for a second home, you will have to settle for another mortgage that is not tax-deductible. Again, it is probably best to hold off until you have enough capital to buy the property outright.
As It Stands
Current tax rules surrounding second homes, vacation homes and investment-class second homes have changed more frequently than those of primary residences. As of now, if you currently own a second home for personal use, you are allowed to rent it, or your primary residence, to another party for up to two weeks (14 nights) without reporting any of the income.
On the flip side, a second home is considered an investment property if you spend less than two weeks in it and then attempt to rent it the rest of the time. It is important to remember that, with the advent of resorts and such, the demand for a cabin in the woods may come only at the peak times--the same period of time you would probably want to use the property.
Although taxes for investment properties have been traditionally softer than for other types of investing, second homes seem to be a gray spot for the IRS. All rental losses are passive losses or hobby losses, and these can only be used against--written-off against--income from other passive activities like other rentals, a private partnership you don't help operate or an S-corporation.
Passive losses that you can't use are carried forward until you sell the vacation home. When you sell the property, the past losses can be used to offset any gains, and, if you have more passive loss write-offs afterward, you can claim them against regular income.
You can, however, deduct up to $25,000 a year, if your adjusted gross income is less than $100,000, or you actively participate in the management of the property. This tax break vanishes at $150,000 adjusted gross income. If you are between $100,000 and $150,000, you qualify for half the deduction. This seems foolish, as most of the people who can afford to buy a second home will have an adjusted gross income far above these numbers.
Still, the real challenge is in the second condition. You can use the yearly deduction if you or your spouse want to become a qualified real estate professional and actively manage the property that is posting the passive losses. Be warned, however, the IRS is not likely to believe that you hold a full-time job and moonlight as a property manager. You will need a detailed journal on why, when, where and what you are doing as a property manager in order to prove your case.
For more information on Chautauqua Lake Real Estate & Living visit: www.chautauqualakehomes.com
No comments:
Post a Comment