Changes in the use of vacation homes can have unexpected tax consequences

During the Corona 19 pandemic, many vacation home owners use their homes in different ways. Because of repurposing, current vacation homes may be treated differently than previous tax revenues for federal income tax purposes.

How might the use of vacation homes change?

Some changes in use are due to the location of the homes and local Crown restrictions. Others are touched by the personal situation of the master. For example:

Alia owns a primary residence in East Cambridge and a rented townhouse on Sanibel Island, Florida. She moved temporarily to the villa last winter to avoid the constraints of the crown. She returned to Massachusetts in April and plans to rent a house in town for the busy summer tourist season. She usually spends less than two weeks a year in Florida.
The Browns live in New York but own a villa in San Diego for personal use. Because of concerns about airline safety, they have not visited their villa since December 2019. In previous years, they had spent a month at their California home each year. The couple recently contacted a management company to get more information about the rental property.
Randall owns a restaurant in Newport that was restricted from operating during the pandemic. He decided to rent his second home, a farmhouse in rural Vermont, to make up for his first lost income.
The Rodriguez family lives in a single-family home near Providence. They also own rental apartments in Chicago. Due to canceled events and travel restrictions in Chicago, the couple has had a significant drop in demand from renters. Their nieces are currently living rent free.
Sam lives in Boston, and her employer recently adopted a permanent remote work policy. She also has a villa in the Smoky Mountains. Sam has decided to sell her Beacon Hill mansion and move permanently to Tennessee to take advantage of Tennessee’s low taxes. But she worries about whether to move into her own cottage or sell it and buy a bigger house near Nashville.

Are you encountering a similar situation? Here’s an overview of the federal tax rules regarding vacation homes to help you make the tax and investment decisions you’re familiar with in today’s unprecedented circumstances.

What is a vacation home?

Resorts for federal tax purposes:

Sleeping quarters, bathroom, kitchen, and
For personal use.

Resorts may include single-family homes, townhouses, condominiums, yachts and houseboats.

Note: If you spend much more time in a villa, your residency may be affected for tax purposes. Each state has different rules. Check with your tax agent for more information.

Can I rent a country house?

You can rent a vacation home to a third party, but the number of days you rent affects your deductible expenses.

Under the rules, vacation homes are rented for less than 15 days per year. These cottages are considered “clean” private homes. This means you don’t have to report rental income, and you can deduct mortgage interest and property taxes as if you weren’t renting the house.(Remember, under current tax law, there are limits on deductions for mortgage interest and state and local property tax items.) The disadvantage is that you cannot deduct expenses associated with the rental property, such as advertising, landscaping and cleaning costs.

The rules state that vacation homes are rented for at least 14 days per year. In this case, the individual portion of the mortgage interest and property taxes of the respective villa can be deducted as an itemized deduction. In addition, you can deduct a portion of the rent and other rental income from these expenses, and you can deduct losses of up to $25,000 per year, depending on your income.

What is a rental property?

For federal tax purposes, if you or your immediate family members use the home for more than 14 days or less than or equal to 10% of the day you rented the property, your vacation home will be classified as rental property, not a private residence.

If your property meets this definition, you cannot deduct the personal portion of the mortgage interest as a rental expense, but you can report it as an itemized deduction. Property taxes (to the extent applicable) will also be the same. Rental income must be reported, but all rental expenses, such as depreciation and overhead, can be deducted under the complex passive activity loss rules.

Tax Tip: If you turn a villa into a residential property before you sell it, you can exclude the pre-sale portion from the tax.

Do it right.

If you are using your villa differently during a pandemic, contact us to schedule a tax planning meeting. Our tax experts identify potential tax traps and help owners adjust planned uses to minimize adverse tax consequences and maximize potential tax benefits.