If you have a home in a vacation destination, it doesn't have to be a vacation home. Depending on how you use it, the Internal Revenue Service may let you classify it as an investment property. Holding investment property carries significant tax benefits, especially if you aren't able to take advantage of the write-offs that the IRS allows on second homes.
Minimal Rental Activity
If you rent your home out for less than 15 days per year or don't rent it out at all, the IRS generally doesn't look at it as an investment property. It considers your rental use of the property so minimal that it doesn't require you to report the rent as income or pay taxes on it. Because of your limited rental use, you will need to treat it as a personal residence.
Meaningful Rental Activity
If you rent the home out for 15 days or more per year, the IRS looks at it as an investment property. The exact way the IRS treats it depends on how much you use it. If you never use it for yourself or for the benefit of your immediate family, it's treated as a pure investment. If you use it for less than 15 days a year and less than 10 percent of the total number of days that it's available for rental, you have to allocate your costs between rental and personal use, but it's still a rental property. Using it for more than either those thresholds still lets you treat it as a rental property, but, in addition to having to allocate your use you lose the ability to write off losses against other income.
When you use a property both for investment and personal use, the IRS requires you to divide it between the two uses, almost like it's two properties. For example, if you have a rental house that is available for rent 100 days a year, and you spend 15 of those days in the house, the house would be considered 15 percent personal residence and 85 percent investment property. If you spend time in the house when it isn't available for rent, you add it onto the total number of days. So, if you stayed for 15 days before the 100 days of rental activity, you'd divide the 15 into 115 days to get 13 percent rental use and 87 percent investment use. You would use these proportions to allocate the expenses for the house.
Vacation Home Taxes
The IRS lets you write off mortgage interest on your second home, provided the combined mortgage debt on your two homes doesn't exceed $1.1 million. If you pay $19,000 in interest a year on your vacation home and it's used for personal use 15 percent of the time, you would claim a $2,850 interest write-off on your Schedule A. You can also write off the personal-use proportion of your property taxes, so you'd also claim $675 of a $4,500 property tax bill as a deduction
Investment Property Taxes
With an investment property, the IRS lets you write off all of the expenses that you incur in owning it, including mortgage interest, property taxes, repairs and utilities. The IRS even lets you depreciate the property and write a portion of its value off every year. To determine how many of your expenses you can claim, look at your investment use percentage. If the house is used as an investment 85 percent of the time, you can subtract 85 percent of all of your expenses against the rental income on Schedule E.
Investment Property Losses
If your vacation home investment property loses money, you might be able to subtract those losses from your regular taxable income. To qualify, you must use the house 10 percent or less of the number of days that it is rented out and no more than 14 days in total. If you rent the house out for 90 days a year, for example, your use would be capped at nine days, but if you rent it for 170 days, your allowable use rises to 14 days. If you meet this test, and your adjusted gross income is $100,000 or less, you can write off up to $25,000 in losses against your other income. If your AGI exceeds $100,000, your write-off is reduced by $1 for every $2 of extra income until it phases out with an AGIs of $150,000.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.