Tax Implications
When exclusively used as vacation property for rent, your investment is eligible for tax incentives that can contribute to a successful venture for you. All business expenses (including mortgage interest, property taxes, insurance, advertising, and maintenance) are allowable deductions against rental income received on the property.
When the gross rental income is greater than your expenses, the profit you make is taxable income. But if the reverse is true, the resulting loss can be used to offset gains from other investments. Keep in mind that personal use of property will affect the tax status so find out in advance the IRS position so there are no rude surprises at tax time.
The general rules about using your own place for a vacation are listed here:
Any vacation property that is rented out for less than 15 days per year is considered a personal vacation home, regardless of how much time you may actually stay there. Mortgage interest and property taxes are deductible, but other expenses are not.
If you rent out a vacation property for 15 days or more in a given year and your personal usage is limited to 14 days or 10 percent of the time it is rented (whichever is greater), then the property is considered rental property. If you rent out a vacation property for at least 15 days in a given year, but your personal usage exceeds the 14-day/10 percent rule, the IRS considers it a second home and therefore, mortgage interest, property taxes, and other expenses are deductible on your rental income only. If expenses exceed rental income, you cannot use the loss to offset other income.
It is important to know that the IRS categorizes repairs and renovations differently and applicable taxes differ. It’s like this: repairs maintain your property in good working order but do not materially add to the value of the property or substantially prolong its life. Repairs are considered expenses and may be deducted like any other business expense. Renovations or improvements increase the value of the property and the costs are treated as capital investments.
Another tax advantage of vacation rental property is that you can deduct the depreciation. This rule takes into account an assumed decrease in value over the years due to regular daily use of the property by many vacationers. . Even if this is not true in your case, you are still allowed to deduct depreciation as a way to recover this assumed loss of value. For rental houses and apartments put on the market after January 1, 1987 depreciation is calculated on a straight-line basis over 27.5 years or approximately 3.63 percent per year. So, if you purchase vacation rental property this year for $137,500, your depreciation deduction would be $5,000 per year for the next 27.5 years. In certain instances, a property may also be entitled to a 30% additional first year depreciation deduction.Since vacation rentals are considered as capital assets, you may be required to pay capital gains tax when you eventually sell. . Usually, if you sell the property for more than you paid for it (or your stake in the property), you have realized a capital gain. But if this gain cannot be offset by other capital losses, capital gains tax on this amount will be due the IRS.
