Making the Best Use of a Personal Residence or Vacation Home Under Today’s Rules
Do you own a personal residence or vacation home? Under today’s rules, what deductions are you entitled to and what do you do about a gain or loss on the sale of such a home? What if you rent a portion of a personal residence or vacation home? These are two common types of residential and rental activities presented in this article.
A primary residence is the dwelling that a person considers their legal residence. A vacation home includes a house, co-op apartment, condominium, mobile home, house trailer, or boat or similar property (must have sleeping, cooking, and toilet facilities). For all personal use property, as in personal primary residences and vacation homes (second residences), the only deductible itemized deductions allowed on Schedule A of your individual tax return are:
- Home Equity Loan Interest
- No matter when the indebtness was incurred, you can no longer deduct the interest from a loan secured by your home to the extent the loan proceeds weren’t used to buy, build, or substantially improve your home.
- Home Mortgage Interest
- You can deduct home mortgage interest on the first $750,000 ($375,000 if married filing separately) of indebtness. Hpwever, higher limitations ($1 million ($500,000 if married filing separately)) apply if you are deducting mortgage interest from indebtness incurred before December 16, 2017.
- Property Taxes, which may be limited if subject to the alternative minimum tax (AMT).
- Points and loan origination fees on a home mortgage designated on the closing statement (Form HUD-1) for the purchase or improvement of, and secured by a principal residence, are deductible in the year paid. Any points paid on a refinanced mortgage, whether personal residence or vacation home, are amortized over the life of the loan.
The cost of capital improvements are added to the cost basis of a property when determining gain or loss on the sale of the property and are therefore not deductible on Schedule A.
Gain or Loss Reporting on Sale of Primary Residence
There are unique rules when determining the gain or loss on the sale of a property. For a primary personal residence, a taxpayer can exclude up to $250,000 of the gain on the sale ($500,000 for married couples filing a joint return and certain surviving spouses). In order to qualify for this exclusion, the taxpayers must have owned and used the principal residence for periods totaling at least two years out of a five year period ending on the date of sale and must not have used the exclusion within the two year period ending on the date of sale. A reduced exclusion may apply if the taxpayer(s) do not meet the two year ownership and use test for:
Certain unforeseen circumstances
Gain or Loss Reporting on Sale of Vacation Home/Second Residence
Form 1040, Schedule D. A loss from the sale of a vacation home or second residence is not deductible and cannot be used as a deduction from gross income.
Part of Home Used for Business
If part of the personal residence is used for business or rental within the same dwelling unit, the taxpayer may still use the home exclusion rules but must recognize taxable gain to the extent of depreciation deductions allowed. An example would be if a home were sold at a gain of $200,000 with accumulated depreciation of $15,000. The home has a gain exclusion of $185,000 and a taxable gain of $15,000, all reported on Form 1040, Schedule D.
Separate Part of Property Used for Business or Rental
If part of the personal residence is not within the same dwelling unit as the residential section, then the taxpayer must record the sale as two separate transactions for determining taxable gain. Examples include working farms, duplexes or a mixed use building where one unit is considered a residence and the other unit(s) is/are rentals.
Converting a Principal Residence into a Rental and Vice Versa
Facts and circumstances have to be considered in the calculation for determining gain of a converted property. Depending on the facts and circumstances, part or all of the gain can be excluded and likewise if there is a loss from the sale of the property.
Rental Income and Expenses
Rental Income, in most cases, must be included in your gross income. A time when it is not reported is if the property is rented for less than 15 days during the tax year. Rental Expenses, in most cases, can be deducted from rental income as long as they are deemed necessary and ordinary to the property such as cleaning and maintenance, taxes, interest, insurance, repairs, advertising, supplies, utilities, etc. Along with these expenses, depreciation expense can be taken, which is determined by dividing the cost basis over the property’s useful life.
If the end result is net income, that amount is included in gross income for tax reporting purposes. A net loss may have limitations based on facts and circumstances as they relate to passive loss activity limitations.
In today’s economy, there are various options and opportunities in real estate. The best decision may be the best opportunity for growth and appreciation with the tax effects being secondary. When looking for the best opportunity, consult with your Withum Real Estate professional for guidance and information on these and many other tax savings opportunities.
All facts and figures noted in this article have come from the Department of the Treasury IRS Residential Rental Property Guide. Publication 527.
The information contained herein is not necessarily all inclusive, does not constitute legal or any other advice, and should not be relied upon without first consulting with appropriate qualified professionals for your individual facts and circumstances.