CARL WATTS & ASSOCIATES

May 28, 2018

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Tax Advantages for
Renting Your Second Home
Among the many changes brought along by the tax reform bill signed into law on December 22 of last year, some strongly affect homeowners starting this year.

First of all, the tax reform has almost doubled the standard deduction, thus reducing the incentive to itemize.




For many homeowners, one important benefit of ownership was the ability to deduct mortgage interest. In recent years, mortgage interest was deductible for the 30% of taxpayers who usually itemized deductions. Of those, three in four claimed a deduction for home mortgage interest.

As of 2018, the state and local property and real estate taxes deduction is capped at $10,000.

From 2018 until 2026 the deduction for interest paid on home equity loans and lines of credit is suspended, unless they are used to buy, build or substantially improve the taxpayer’s home that secures the loan.

For anyone considering taking out a mortgage, the new law imposes a lower dollar limit on mortgages qualifying for the home mortgage interest deduction. Beginning in 2018, taxpayers may only deduct interest on $750,000 of qualified residence loans. The limit is $375,000 for a married taxpayer filing a separate return. These are down from the prior limits of $1 million, or $500,000 for a married taxpayer filing a separate return.


The limits apply to the combined amount of loans used to buy, build or substantially improve the taxpayer’s main home and second home. With the new law, for current mortgage holders, there is no change. But the deductible limit drops to $750,000 for new debt incurred after Dec. 31, 2017.

Also, homeowners may not claim a deduction for existing and new interest on home equity debt, beginning Jan. 1, 2018.

So, what about those of you who own a second home? Well, unless you are reluctant to rent out your second home, then there is no limit on how much mortgage interest or real property tax can be deducted, provided you abide by the IRS rules on vacation rentals.

Here are some of the most important rules of renting your vacation home.

First of all, a vacation home may be a house, an apartment, condominium, mobile home, boat, vacation home or similar property.


If you use a vacation home as a residence and rent it for fewer than 15 days per year, you do not have to report any of the rental income.

If you don’t use your vacation property yourself and receive rental income for it, you may deduct certain expenses. These expenses, which may include mortgage interest, real estate taxes, casualty losses, maintenance, utilities, insurance, and depreciation, will reduce the amount of rental income that is taxed. You will generally report such income and expenses on Form 1040 and on Schedule E, just like with any other ordinary rental property.

Without personal use, the home is considered an investment or rental property by the IRS. Time spent checking in on a house or making repairs doesn’t count as personal use.

In this case, your deductible rental expenses may be more than your gross rental income. Your rental losses, however, generally will be limited by the "at-risk" rules and/or the passive activity loss rules.

Different rules apply if you use a vacation home as your residence and also rent it to others.

It is possible that you will use more than one dwelling unit as a personal residence during the year. For example, if you live in your main home for 11 months, your home is a dwelling unit used as a personal residence. If you live in your vacation home for the other 30 days of the year, your vacation home is also a dwelling unit used as a personal residence unless you rent your vacation home to others at a fair rental value for 300 or more days during the year.



You are considered to use the property as a residence if your personal use is more than 14 days, or more than 10% of the total days it is rented to others if that figure is greater. For example, if you live in your vacation home for 17 days and rent it 160 days during the year, the property is considered used as a residence and your deductible rental expenses would be limited to the amount of rental income.

A day of personal use of a dwelling unit is any day that it is used by:

You or any other person who has an interest in it, unless you rent your interest to another owner as his or her main home under a shared equity financing agreement;

A member of your family or of a family of any other person who has an interest in it, unless the family member uses it as his or her main home and pays a fair rental price;

Anyone under an agreement that lets you use some other dwelling unit;

Anyone at less than fair rental price.

If you use the dwelling unit for both rental and personal purposes, you generally must divide your total expenses between the rental use and the personal use based on the number of days used for each purpose.

When owned property is used for vacation purposes and is rented out part of the time, that property must be treated the same way as a business would. For example:

Receipts and invoices for repairs, improvements, and services should be kept.


You should have a separate checking account for the receipt of rent payments and for payment of rental expenses such as cleaning after a renter vacates. Not only will this separation make accounting easier, but it will also keep the IRS happy.

The days that the vacation home is used for personal use should be tracked. It's not enough to know off the top of your head what days were spent at the vacation property. Instead, a designated calendar should be employed that clearly shows both personal and rental use to be absolutely sure the use meets the IRS tests for vacation homes.

However, you will not be able to deduct your rental expense in excess of the gross rental income limitation (your gross rental income less the rental portion of mortgage interest, real estate taxes, and casualty losses, and rental expenses like realtors' fees and advertising costs).

Even so, you may be able to carry forward some of these rental expenses to the next year, subject to the gross rental income limitation for that year.

Another important aspect to be mentioned is that, if you have a rental income, you may be subject to the Net Investment Income Tax.

You must also keep in mind that, generally, any short-term rentals, typically called transient rentals, even just for a weekend, may have a state and local tax obligation.

Nevertheless, with the new tax law, it might no longer make financial sense to leave your vacation home empty.

Please consider this newsletter as just an introduction to all the information about rental property, including special rules about personal use and how to report rental income and expenses. You can find out more details in IRS Publication 527, Residential Rental Property (Including Rental of Vacation Homes) available at IRS.gov.


Of course, as we will always advise you, a good tax professional can help you organize the data for the business and personal use of your second home. They can also discuss with you the best ways to minimize taxes on both your rental income and ultimate sale.
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