A vacation home can be many things to different people. For example, it can be a relaxing refuge for friends and family, or the property can serve as an income-producing investment if you choose to rent it out when you are not using it.
However you plan to use your vacation home, it pays to understand the tax rules regarding income and expenses associated with the property. To ensure that the home stays in the family, it is important to be familiar with specific estate planning strategies.
You can generally deduct interest on up to $1 million in combined acquisition debt on your main residence and a second residence, such as a vacation home. However, be aware that the $1 million amount may be limited to $750,000, depending on when the debt was acquired. In addition, you can also deduct property taxes on any number of residences, although the deduction for state and local taxes is limited to $10,000
If you use the home for at least 14 days and rent it out for less than 15 days during the year, the IRS will consider the property a "pure" personal residence and you do not have to report the rental income. But, any expenses associated with the rental, such as advertising or cleaning, are not deductible.
If you rent out the home for more than 14 days and you occupy the home for more than the greater of 14 days or 10% of the days you rent the property, the IRS will still classify the home as a personal residence (in other words, vacation home), but you will have to report the rental income.
In this situation, you can deduct the personal portion of mortgage interest, property taxes and casualty losses as itemized deductions. In addition, the rental portion of your expenses is deductible up to the amount of rental income. If your rental expenses are greater than your rental income, you may not deduct the loss against other income and the loss carries forward.
If you use the vacation home for 14 days or less, or under 10% of the days you rent out the property—whichever is greater—the IRS will classify the home as a rental property. You must report the rental income and may deduct all allocable rental expenses, including depreciation, subject to the passive activity loss rules.
Planning for the future
As with any asset, it is critical to account for your vacation home in your estate plan. What will happen if an owner dies, divorces or decides to sell his or her interest in the home? It depends on who owns the home and how the legal title is held. If the home is owned by a married couple or an individual, the disposition of the home upon death or divorce will be dictated by the relevant estate plan or divorce settlement.
If family members own the home as tenants-in-common, they are generally free to sell their interests to whomever they choose, to bequeath their interests to their heirs or to force a sale of the entire property under certain circumstances. If they hold the property as joint tenants with rights of survivorship, an owner's interest automatically passes to the surviving owners at death. If the home is held in a Family Limited Partnership or LLC, family members have a great deal of flexibility to determine what happens to an owner's interest in the event of death, divorce or sale.
Keep it in the family
If your vacation home has been in your family for generations, you will want to do everything possible to hold on to it for future generations. Contact your advisor to learn more about the tax and estate planning aspects of owning a vacation home.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.