Vacation homes offer a respite from the daily grind of life, allowing you to get away and enjoy time with family and friends. Although they are also sound investments that can increase your net worth over time, they also carry tax breaks you should know about.

Before you can examine the kinds of tax breaks you can claim for your vacation home, it’s important to understand the difference between a primary residence and your second home, or vacation home. Your primary residence is the home in which you live for the majority of the year. Your second home may be a residence in which you live part of the year, but not necessarily day-to-day. It may also be a rental residence in which you don’t live at all.

Mortgage Interest Deduction

The mortgage interest deduction is limited to interest on mortgages not exceeding $750,000 for primary and a second residence of the taxpayer.The second residence can be a vacation home. It must be used as a residence for the greater of 14 days or 10% of the number of days it is rented at fair market value.

The limit for mortgages entered into prior to 2018 is $1,000,000.

However, if your second home is actually a rental home, it’s more complex.

If you rent your second home for more than 14 days and your use of the home doesn’t exceed the greater of 14 days or 10 percent of days it’s rented, the IRS classifies the home as a rental property. You can then treat the home as a business, allowing you to deduct mortgage interest, taxes, utilities, and even depreciation. However, you’ll need to report your income on the property, and depending on your expenses, that could result in a higher tax bill.

Income Tax Break

Speaking of rental income, you’re not required to report your rental income to the IRS if you rent your home for 14 days or fewer each year.

This is a tax advantage that could be a potential boon for those who live in an area where their home is particularly sought-after during an event or during a certain period of the year, since all of the income generated in a two-week period is theirs, free and clear.

Real Estate Taxes

Just as with a primary residence, taxes on a second home are deductible. However, since 2018, state and local tax deductions have been limited to $10,000 in total. So if your primary residence taxes are already over that threshold, you cannot deduct your second home’s taxes.

Selling a Second Home

The gain on the sale of a vacation home is subject to federal, state, and local capital gains taxes. The gain on sale of a principal residence is subject to the same taxes but there is a $500,000 exclusion for married individuals, $250,000 for single married filing separately.

It may be possible with a lot of foresight to convert a vacation home to a principal residence for tax purposes. This will require using the vacation home as a principal residence for a period of 2 years out of the 5 years prior to the date of sale. Even if this is possible, there are rules which require the gain to be apportioned to the time period it was rented, compared to the time it was used as a residence. The result is that part of the gain will not be sheltered by the exclusion.

Looking Ahead

Owning a vacation home is personally very satisfying and if you want to rent it out there are financial and tax advantages. Speak to your Perlson Professional prior to purchase so that you understand the financial cost of owning a second home.

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