The American Dream of buying a home has undergone a fair amount of change over the last 50 years, expanding to second, or vacation, homes. But these cottages on the lakeside, the cabins in the mountains and the huts on the beach often 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 vacation home collect dust when you can’t be there: Rent it to other people looking to enjoy some time away from work. While renting can be lucrative, you’ll need to consider the tax implications.
- The IRS deems a second home an investment property if you spend less than two weeks staying in it and attempt to rent it for the rest of the time.
- Rental losses can only be written off against income from other rentals, a private partnership you don’t operate or an S-corporation.
- The length of time you have owned a vacation home affects what capital gains taxes you pay.
- If you own a second home for the purpose of renting it, and you have an AGI under $150,000, start actively managing it.
Affording a Second Home
Buying and maintaining a secondary residence is an enormous financial decision. A second home has all the costs of your first home and often more but without the easy write-offs from the IRS.
If you’re considering buying a second home, one of the first steps is to decide whether you will finance the purchase with a mortgage or if you will pay cash. To help you decide, use a mortgage calculator to research interest rates from lenders in the area where your vacation property is located. Then, once you’ve gathered estimates of the total cost of your monthly mortgage payments, go over your financials to see if it makes more sense to take out a mortgage or to pay cash.
If you are set on getting a vacation home but don’t have the capital for an all-cash purchase, be aware that the IRS has closed the loophole in which you could use a second mortgage to purchase a separate investment property while still deducting your payments as personal mortgage interest. If you intend to borrow for a second home, you will have to take out another mortgage that allows for tax-deductible interest.
The number of homes in the U.S., equivalent to 5.6% of the total housing stock, that qualify for the second home mortgage tax deduction, according to the National Association of Home Builders and the Census Bureau.
The IRS on Vacation Home Investments
If you own a home and rent it for fewer than 15 days, you don’t have to report the income. However, the IRS considers a second home an investment property if you spend less than two weeks in it and then attempt to rent it for the rest of the time. It is important