The rise in the online travel industry and vacation rental services like Airbnb have dramatically increased the demand for home rentals, especially in areas known for tourism. Along with that rise, more Americans are buying and owning vacation homes not for pleasure, but for profit. About two-thirds of vacation homeowners rent out their properties, and thanks to available tax deductions, they can often cover the costs of ownership – and maybe even turn a profit. Here’s how.
If the vacation home is primarily a rental property, almost any expense to maintain it is tax-deductible. Here are the big ones, which are similar to owning a primary residence:
Tax Breaks for Buying the Vacation Home
Buying a home obviously requires ongoing maintenance, and to claim a depreciation expense against the property’s normal wear and tear, it’s important to keep good records. You can only depreciate the building value, not the land value, and it’s best to use the straight-line depreciation method. The current depreciation rate for residential rental property is 27.5 years.
The initial mortgage to purchase the vacation home comes with potentially significant tax breaks. Mortgage interest is tax-deductible, as with a primary residence. And if points or loan origination fees were paid at the beginning, those costs are deductible as a form of interest. Down payments are non-deductible.
When you buy the vacation home – and throughout home ownership – if you work with a CPA or lawyer, keep track of those expenses. Lawyers’ fees to review lease documents or CPA fees for tax planning or bookkeeping are deductible expenses.
Tax Breaks for Maintaining the Vacation Home
It’s normal to take out loans and lines of credit to make purchases, repairs, and improvements on your vacation home. You can deduct the interest on these expenses., as long as you keep proper records. Besides the mortgage interest deduction, other interest expenses can include:
- Unsecured Loans
- Any interest on unsecured financing for the vacation home could be tax-deductible.
- Credit Cards
- If a homeowner buys supplies, appliances, or furniture, for example, on a credit card, the interest for those purchases would be tax-deductible. If the credit card is used for anything else besides vacation home expenses, work with a CPA to accurately track the interest of applicable purchases as the calculation can become complicated when mixed with other non-qualifying purchases.
You’ll also pay property taxes, homeowner’s insurance, and in some areas, licensing fees to rent out the vacation home. All of these fees are tax deductible. Since property taxes and homeowner’s insurance for vacation homes tend to be more expensive than primary residences, these are expenses worth noting for tax purposes. Examples of insurance policies that are deductible include general liability, hazard and fire, flood, sewer backup, and loss of income.
Paying for utilities like heat, water, electricity, internet, and even private trash removal or recycling are routine costs of maintaining a vacation home and tax deductible. If the person or family using the property reimburses you for any amount of utility costs, make sure to record it as income.
Homeowner fees and related expenses are also deductible, since they’re required to own the property. Also, if a homeowner’s association has certain requirements for say, rent signs, you can deduct those costs as well.
Managing the property is deductible too, and there are couple ways to do it. One is if you use a property management firm. In that case, separate commissions as marketing fees, not management fees. Any fees paid to on-site property managers, like salary and benefits, are deductible expenses. If you manage the property yourself, which is the case for many homeowners, it might be worth considering setting up an LLC so you can employ yourself as the property manager and collect a reasonable salary.
Tax Breaks for Repairing the Vacation Home
Whether you make planned improvements to the vacation home or need to repair a broken outlet, costs associated with those activities are deductible. There are key differences, though.
Repairs that cover normal wear and tear or after, say, a bad storm, are tax deductible. Things like replacing carpets, repainting rooms, repairing broken glass or a faulty faucet, would be considered repairs.
Improvements, on the other hand, are treated as long-term benefits and are therefore depreciated over time. For example, a roof replacement, new air conditioner, or energy-efficient appliances would be depreciated (and you could use the 100 percent bonus depreciation in year one as an added benefit).
In addition, things like office supplies, paint supplies, cleaning products, hardware, and other maintenance supplies are related to the upkeep of your vacation home and should be tracked.
Tax Breaks for Marketing the Vacation Home
If you take out an ad or otherwise promote your vacation home for tenancy, keep track of the receipts. Even expenses like subscriptions to online travel home listings or the costs to design and print a marketing brochure are deductible. Another marketing expense is if you work with a real estate agent to book rentals. Commissions can be steep but are tax deductible.
Is your vacation home working for you? Use these tax breaks to make the most of owning a second home. Also remember that if you rent out your vacation home for 15 or fewer days per year, you won’t owe rental income tax. If you have questions on the tax benefits and possible tax traps of owning a second home, don’t hesitate to contact our office.