Special Considerations for Second/Vacation Homes
How do you insure a vacation home?
You'll want to insure your vacation home against damage and loss. Your homeowners policy will provide liability coverage for you at your vacation home. However, most homeowners insurance policies provide only limited coverage for personal property at an additional residence. To insure the vacation home itself and to obtain additional personal property coverage, consider purchasing a dwelling and fire policy. There may also be insurance issues depending on how much of the year the property will be vacant. For more information, contact an insurance professional.
What are the income tax consequences of owning a second or vacation home?
The income tax treatment of your vacation home depends on how many days you rent it to others, and other factors.
If your second home is for your personal use only, or is rented to others for less than 15 days per year, the income tax treatment is straightforward. If you meet the requirements, you may deduct the following items:
– Property taxes
– Qualified residence interest
– Casualty loss deductions
Tip: Rental income received from such a home is not subject to tax.
Caution: Because you don't report the rental income generated from this home, you can't deduct the expenses related to the rental.
If you rent the home out for 15 days or more during the year, and your personal use of the home exceeds the greater of 14 days during the year or 10 percent of the days rented, then the property is considered a vacation home for tax purposes. The tax treatment is as follows:
– Rental income: All rental income is reportable.
– Rental expenses: Rental expenses must be divided between personal use and rental use of the property.
Deductible expenses, such as insurance, repairs, utilities, and depreciation, are generally limited to the amount of income generated by the property.
Other deductions: You may deduct qualified residence interest, property taxes, and casualty losses.
Caution: Mortgage interest is considered qualified residence interest if it is incurred with respect to your principal residence and one other residence. So, you won't be able to deduct the mortgage interest on more than one secondary residence or vacation home. There are also limits on the amount of indebtedness that may be taken into account in determining the amount of qualified residence interest that is deductible each year.
If you use your home less often for personal purposes (i.e., you don't meet the 14 day/10 percent rule), your vacation home is considered strictly rental or business property. The tax treatment is as follows:
– Rental income: Gross rental income is taxable to the extent it exceeds the rental-related expenses.
– Rental expenses: All expenses, including mortgage interest, property taxes, insurance, advertising, and so on, can be deducted against the rental income received on the property. You should report these expenses on Schedule E of your federal income tax return.
– Losses: If the total rental expense exceeds the gross rental income, then the resulting loss may be deducted from your personal income (subject to relevant limitations, including the limitation on the deduction of passive losses).
Caution: Unlike the sale of your principal residence, you aren't allowed a capital gain exclusion when you sell rental property or second/vacation homes. However, if you own and use the home as a principal residence for two out of the five years preceding the sale of the home, you may qualify for capital gain exclusion, even though the home was a rental property or vacation home for the balance of the five-year period. For more information about the tax treatment of rental property, see our separate topic discussion, "Sale of a Principal Residence Converted to Rental Property." For more information about the tax treatment of vacation property, contact our office or your certified tax accountant.
This information in this article is general in nature and should not be considered specific advice for any individual. NPC is not engaged in the rendering of tax advice.
Bill Kumm is Senior Partner at Financial Independence and the host of "The Retirement Income Show" on WTCM NewsTalk 580am, Sundays at 12 p.m. 231.421.5422.