What To Know If You Just Bought A Vacation Home

What To Know If You Just Bought A Vacation Home

What To Know If You Just Bought A Vacation Home 1000 667 Ryan Holloway

Buying a vacation home as an investment opportunity isn’t a one-season affair.

Not only does having a rental mean potentially maintaining your property and setting up renters, but also knowing how to maximize your tax benefits for how much it’s being used. This can be a tricky road to navigate, and unless your property is a traditional rental property (such as a beach house), assessing the usage versus maintenance versus taxes to file under can lead to a lot of questions. However, that’s why we’re breaking down a few of the key considerations to go over if you just bought a vacation home.

Decide If You’re Going To Use This For Passive Income Or Not

The biggest consideration you should have over a vacation home is if you’re going to use it for passive income or not. 

Even if you decide to list and rent through a property management company, there may be revenue to report and taxes to pay, as well as a separate process for what type of filing/schedule you need to provide to the IRS. Although renting a vacation home can be a great way to make some extra cash, there are also some tax incentives for keeping it for personal use, especially if the rental market isn’t that strong. Here’s a breakdown of how the IRS views the difference between them, as well as what incentives are there for you:

  • First, if a vacation home is for personal use, you can deduct the interest if you are considering it a second home (subject to mortgage limitations).
  • Second, a home is considered for personal use if it’s used for more than 14 days or 10 percent of the total days you rent it at a fair rental price. For example, the IRS notes you can live at a residence for 11 months out of the year and stay at your vacation home for one month, while still having it be considered for personal use. 
  • Furthermore, the IRS defines ‘personal use’ of a vacation home as:
    • Yourself or anyone who has an interest in it (such as someone you bought-in on it with you).
    • Your family, or the family of someone who has an interest in it.
    • Anyone under an agreement that lets others dwell in the unit.
    • Anyone renting at less than a fair rental price.

Finally, any rental under 15 days doesn’t need to be reported, which we’ll note a little later on why that can be a smart rule to consider.

A Note On How The Tax Cuts and Jobs Act Changed Mortgage Payments

As noted in AccountingToday, the Tax Cuts and Jobs Act (TCJA) changed the limit on acquisition debt from $750,000 ($365,000 for a married taxpayer filing separately). This matters if you’re trying to use your vacation home under personal usage; for example, if you take out a loan for your home at $400,000 and then take out another for a vacation home at $300,000, as long as the total for both doesn’t exceed $750,000, the interest is deductible.

Know What Type Of Filing Applies For Rental Income Versus Personal Use

There are two types of filings for passive income versus personal use on vacation homes. 

The first is that a home used as a primary residence would use Schedule A for its deductions, while a rental home would use Schedule E, which also includes depreciation, such as lost value due to wear and tear on a home. Using the 14-day rule, this should be relatively easy to figure out, with the intent of the home’s usage as the biggest factor in deciding.

The biggest consideration you should have over a vacation home is if you’re going to use it for passive income or not.

Divide Up Your Expenses Based On Rental and Personal Use

A big reason why scheduling your vacation home correctly is important is that it differs what type of expenses you’re able to divide up.

As a rental property, you can deduct real estate taxes, interest, insurance, utilities, housekeeping, household items (such as bedding, furniture, etc) and repairs.

For personal property, you can still deduct the mortgage interest and taxes, however, other business expenses won’t count if you didn’t rent it for more than 15 days.

Should I Make Renovations?

Making renovations can be a great call for your vacation home. Particularly if you’re planning to use it as a rental, fixing things up can not only help increase the value, and thus, the rental price, but also give you potential tax credits as well. Some popular choices include:

Historic Tax Credits

A good choice for those buying vacation homes in older cities or towns, historic tax credits give you up to 20 percent per dollar federally, with even more deductions on a state and even local level in certain instances. If you’re a first-time buyer of a vacation home and have the time or resources to invest in a historic property, the tax credits can help quite a bit to maximize the value of your rental.

Renewable Energy Credits

As noted by The Balance, there are three applicable percentages you can claim for renewable energy credits:

  1. 30 percent for property placed in service after December 31st 2016 and before January 1st, 2020
  2. 26 percent for property placed in service after December 31st 2019 and before January 1st 2021
  3. 22 percent for property placed in service after December 31st 2020 and before January 1st 2022

Especially those with residential properties generating passive income, installing energy-efficient and renewable sources helps quite a bit in both savings on the utility bill while also maximizing your profits on the unit. Look into saving a little bit towards installing renewable energy resources, as these can be a win-win on both tax savings and cost for maintaining a unit.

How Can I Maximize The Best Tax Situation?

Ultimately, the biggest question you need to ask yourself for a vacation unit is how often you’re going to use it versus how often you’re going to rent it.

There are a few different avenues to go down for the best tax situation. For example, if you’d like to maximize the 14-day rule for rentals, then perhaps having a home that can be used for weddings or other DIY events that charge per hour might be wise. Additionally, knowing that the property’s intent as a rental isn’t a bad route to go either, as maximizing expenses and other credits for it becomes much easier. Ultimately, a vacation rental purchase really boils down to what you want out of your vacations personally, as well as what you want to rent for others. And if you’re wondering how to get the best tax opportunity out of your situation, don’t hesitate to reach out at the email address below.

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