You may have been told that owning a second property can provide some form of tax relief. While there is some truth to this, it is not quite so cut and dry.
Before adding a new mortgage to your debt, you should make sure that you understand the tax implications that come with owning a second home. This starts with deciding how you plan on using your second home.
You might want a vacation retreat for the winter or summer. Or, you might decide to make a little income by renting out the property. You could even purchase the home through your small business.
Once you’ve defined the use of the second property, you are able to explore the various tax breaks. You may have originally planned on using the second home as a vacation property. But, you could find that it is more advantageous to rent the property out for a portion of the year.
Take a detailed look at each option and gain a better understanding of taxes for second homes.
Defining the Use of the Second Home
The tax implications of owning a second home will depend on the intended use of the property. The amount of time spent residing in the home will directly impact the taxes that you pay.
So, before getting into the taxes, it’s important to define the use of the second home:
- Rental property
- True second home
- Business property
Rental properties and business properties both offer additional tax breaks. Owning a true second home provides tax breaks similar to your first home.
When Should You Consider Renting the Property?
In order for the second home to be considered a rental property, you cannot spend more than 14 days residing in the property. Or, ten percent of the total days rented.
For example, if you rent the property to other families for 150 days out of the year, you could not reside in the property for more than 15 days.
When you own a rental property, there are quite a few deductions that can go on your tax return. This includes the following:
- Mortgage interest
- Property taxes
- Mortgage insurance
- Maintenance and upkeep
- Miscellaneous expenses
These deductions are only available if the property remains a rental property. Though, this is not the only way to make money from your second property.
You can continue to use your property as your own personal vacation home and rent it out for up to 14 days per year. The rental income that you earn will not need to be reported. But, the home will be considered a personal property and you will not gain all the tax breaks listed above.
What are the Benefits of Having a Vacation Home?
When you exceed the limit for rental properties, the home is considered a personal property. A true second home will also offer some tax benefits, along with a few restrictions.
The available deductions are similar to your first home. You can deduct your mortgage interest and property taxes.
You also get to claim up to $250,000 in tax-free profit when selling your home, as long as you lived in the property for two years during the last five years. This goes up to $500,000 for a couple. The profit is taxed when selling a rental property or a property purchased through an LLC.
Why Would You Purchase the Home Through an LLC?
The third type of use for a second home is a business property. By purchasing the second home through an LLC, the property will not be added to your personal net worth.
By not adding the property value to your net worth, you can keep yourself within the limit for tax-free estate planning. When your total assets exceed $5.43 million ($10.86 million for couples), your estate will get taxed when it is passed to a surviving spouse or next of kin.
In some areas, commercial office space is unavailable or limited. Purchasing a second home through an LLC (limited liability company) provides a solution for small businesses. Lawyers, family physicians, accountants, and other professionals often go this route.
It’s also possible to purchase the home through your LLC and then turn around and rent the property. You could rent it to yourself or to other families.
The benefit of this is that you do not need to add the net worth of the home to your personal net worth. Also, you can take advantage of the tax breaks discussed above for rental properties.
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Final Thoughts on Purchasing a Second Home
Each option provides its own advantages and disadvantages to your tax plans. Whether you choose to use your second home as a vacation home or as a rental property, you will need to pay attention to the tax implications.
The second home can only be considered a rental property if you spend 14 days or less living in the home. Or, 10% of the total number of days the property was rented.
With a rental property, you get to deduct real estate taxes, utilities, maintenance, and upkeep on your second home. Though, you miss out on the tax-free profits if you decide to sell the home.
Using the second home as a vacation property is always an option. Though, the only real tax benefit that it brings is being able to claim the tax-free profits when selling the property. You will simply receive the same deductions that you receive for your first home. This includes mortgage interest and property taxes.
If you want to get the most out of your available deductions, you should consider working with a tax professional. They will understand how the second home will change your taxes. And, they can even offer guidance to help you decide on the best option for your specific situation.
In the end, most people will simply want to own a second home as a vacation property. The deductions are simple – they’re the same as your primary residence, according to ABC Law Utah.
As a bonus, you could rent it out for less than two weeks and pocket the rental income as tax-free profits.
Troy has been married for 27 years to his wife Shauna. They have six active children and they love to participate in many extracurricular activities including: boating, flying, mountain biking, hunting, fishing, horseback riding, and adventure motorcycling (pretty much whatever will get them outside).
Troy has a vast amount of experience in the following business sectors: medical, dental, manufacturing, retail, restaurants, construction, farming and ranching.
He is a shareholder in Cook Martin Poulson a Utah Accounting Firm.