You can treat a second home as a rental property and generate some tax benefits -- along with some possible tax consequences. The two primary differences, which each have thier own advantages and disadvantages, are the type of mortgage financing available and the tax treatment of your home, depending on the number of days you rent it. Consult with a tax adviser to get up-to-date advice to maximize tax benefits and minimize tax cons.
There are usually better terms and interest rates for second homes than for rental properties. However, you need enough monthly income to afford a mortgage on your primary residence and the loan on your vacation home. If you classify your second home as a rental property, because you'll receive income, it is usually much easier to qualify for a mortgage. However you will not enjoy second home terms and rates. You may need up to a 30 percent down payment, instead of around 20 percent, and you will pay higher interest rates with a rental home. Tax deductibility will vary based on other factors.
Interest and Property Tax Deductions
When you do not rent your second home for more than 14 days a year, you can deduct all of the mortgage interest and property tax you pay, just as you can for your primary residence. Once you rent it for more than 14 days and still occupy your second home at times, you must pro-rate interest and property tax costs. For example, if you occupy your vacation home for 50 days per year and rent it for 150 days, you can deduct 75 percent of interest and property taxes you pay.
The 14-day rule may limit becomes more complex for tax purposes. When you occupy your second home for longer than 14 days, or more than 10 percent of the number of days you rent it, the Internal Revenue Service considers it a personal residence. You would still pro-rate most operating expenses, like insurance, utilities, rental commissions and fees, or other costs associated with your home. Since your second home is classified as a personal residence, your interest does not count as a rental expense, but you could deduct 25 percent (100 minus 75 percent) of your mortgage interest paid per IRS regulations.
Using your second home for more than 14 days, or more than 10 percent of the days you rented it out, eliminates your ability to claim a tax loss. Should you limit your personal use to less than 14 days or 10 percent of rental days, your second home is considered a business. You then are allowed to deduct up to $25,000 in losses each year. To qualify for the tax treatment, however, you must limit your personal use of the property if you want it to be treated as a business for tax purposes.
If you rent your second home for 14 days or less, you face no tax consequences. You can keep the income tax-free, even if you are able to rent it for $15,000 per week. Once you exceed that 14-day rental maximum, however, you must declare and report every penny of income you receive. Your rental income should help you qualify for an investment mortgage loan, but it could increase your personal income tax liability.