11 Jul 2021 Tax Advice for Owning a Second Personal Use Home
Authored by: Gregory M. Ward, CPA, Haynie & Company Tax Manager
Tax Advice for Owning a Second Personal Use Home
Second home ownership can provide an array of benefits. The home can offer a weekend getaway, a rental property generating reliable cash flow or something in between. While rental properties offer their own complexities, it is just as important to understand regulations governing personal use or vacation homes.
We can only grasp the tax benefits of a second home by understanding how the IRS classifies various property:
- Primary Residence: Your main abode (driven by personal and work factors).
- Additional Personal Residence: Any property used personally for more than the greater of a) 14 days or b) 10% of the total days rented to others. This can include second homes.
- Rental Property: Any personal residence rented for 15 or more days OR any non-personal residence rented for any duration.
Real estate taxes paid on vacation homes are deductible up to the combined $10,000 limit imposed on state, local, personal property, and income taxes. Mortgage interest paid on a second home is deductible, subject to certain debt security requirements and a $750,000 overall mortgage debt limit. There are no minimum usage or occupancy requirements to consider a property a second home. Interest paid on a third or additional home will not be deductible unless the taxpayer acquires it for investment purposes.
Additional property expenses are generally not deductible unless the home generates rental income. Upkeep and property management costs had previously been deductible on Schedule A as ‘Miscellaneous Deductions’. However, the Tax Cuts and Jobs Act suspended that category from 2018 through 2025.
Vacation homeowners need to be conscious of the 14 days / 10% of total rental days test. If they exceed the greater of these amounts, any rental losses generated on the property will be non-deductible. In most other cases, taxpayers can deduct rental property losses up to certain income limits. Deductible expense items would also require limiting according to the ratio of rental days to personal days. These personal days include usage by:
- the taxpayer
- any other property owner
- members of any owner’s family
- individuals staying under a reciprocal arrangement
- silent auction recipients
- or any other rental arrangements for less than fair market value
Staying under these day amounts helps to ensure simpler reporting and minimal taxable income.
On the bright side, homeowners can benefit by renting their second homes for fewer than 15 days. A special provision allows taxpayers to exclude this gross rental income from taxable income, regardless of total rent collected. This tax code section is known as the “Masters Exemption” due to the 1970s lobbying efforts of homeowners near the Augusta, GA site of the golf tournament. It is one of many fascinating examples of the tax policymaking power of special interest groups. An important note – taxpayers must meet the 14 days / 10% of rental days test to receive this benefit.
When planning, remember that second homes do not afford the $250,000 per taxpayer gain exclusion available for principal residences. Taxpayers with substantial unrealized property gains and a flexible sale timeline have a couple of options. They might consider a like-kind exchange or converting the property to a principal residence to avoid a large liability. The like-kind exchange eliminates gain recognition if the taxpayer purchases real estate for equal or greater value immediately after the sale of the second home. To qualify, the homeowner would need to convert the property from a second home to one held for investment. This change would necessitate minimal personal use and a pattern of investment activity leading up to an eventual sale. Principal residence conversion entails occupying the property as the primary abode for 2 years before selling to exclude realized gains.
Second homes can also be a useful tool for wealth management and estate planning. Like other capital assets, inheritor(s) of the home receive a “step-up” adjustment to cost basis upon the original owner’s death. This effectively eliminates any appreciation gains from ownership and allows for a tax-free sale by the heirs. President Biden’s tax plan proposes eliminating this step-up benefit, but Congress has not offered legislation to codify this change.
For properties with mixed personal and rental use, taxpayers must document details of each occupancy to support tax positions. These records should include dates, visitors, reason for visit, number of nights, support for fair market rental value, etc. Without clear evidence to the contrary, the IRS has a track record of disallowing deductions due to additional personal-use days or voiding the under-15-day gross rent exclusion. Some reasonable planning and recordkeeping can ensure that you enjoy all the tax benefits available to vacation homeowners.
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