The weather is warming up. Your retired friends are coming back from Florida. Not only did they avoid the cold, but they also got a tax break. Right? In the context of this article, it’s important to differentiate between state income taxes and the tax considerations of owning a vacation property. This article is all about the latter. A future column will address the former.
Before we get into the meat of it, I’ll break the bad news: It is almost never a good financial move to buy a second home. With the advent of Vrbo, Airbnb and similar services, it’s almost always cheaper to rent than it is to buy. Remember, for purposes of this article, we are not factoring in state income taxes that could be saved if you buy a second home and meet residency requirements in a tax-friendly state. That said, below are three ways you can make the math more favorable.
1. Rent out your vacation home for two weeks or less.
By definition, a vacation home is not a rental or investment property. Rentals are reported on Schedule E and have completely different rules than a vacation home. However, the IRS allows you to rent your home for 14 days or less without having to report that income. This can be especially impactful for homes in popular tourist destinations and has been coined the “Masters exemption” because of how much tax-free income is earned by those with homes in Augusta, Ga., during Masters week. Think beach towns during Memorial Day and Labor Day. Think college campuses during homecoming and graduation weekend.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
2. Take advantage of the mortgage interest deduction.
Yes, you can deduct mortgage interest on a second home. However, there are a few things to be aware of. This benefits you only if you itemize deductions. On your form 1040, Schedule A reports itemized deductions. You add up all your deductions, and if that number is higher than the standard deduction, you itemize. The standard deduction was doubled as part of the Tax Cuts and Jobs Act (TCJA), and many of the deductions were capped. According to the Tax Foundation, only about one in 10 taxpayers itemizes. To see a benefit from your vacation property, you must be in that 10%.
The TCJA also reduced the amount of mortgage debt that you can use in this calculation. You cannot write off interest on aggregate balances of more than $750,000. Therefore, if you already have a $500,000 mortgage, only $250,000 of debt on a second mortgage property will give you a tax break.
3. Take advantage of the property tax deduction.
Property tax deductions can also be found on Schedule A. This is very similar to the rule above because you must itemize deductions to see any benefit. Also similar is that there is a cap on the deduction because of the TCJA. This is the dreaded “SALT cap.” You are allowed to deduct a maximum of $10,000 in state income taxes and property taxes paid. Most of our clients hit that cap without a second home. In lower-cost areas, you may see a marginal tax savings by writing off a bigger property tax bill.
As I often preach, use your financial plan as a guide to ensure that you can afford a second home. If you want to double-check your plan, you can use this free software.
Once you’ve received the green light from the plan, consider the qualitative factors. What does upkeep look like? How much time will you be able to spend there? You don’t ever want trips to your vacation home to feel like an obligation. If you decide to go for it, give me a shout — I’d love to visit!
Related Content
-
Stock Market Today: Stocks Rally Despite Rising Geopolitical TensionThe main indexes were mixed on Tuesday but closed well off their lows after an early flight to safety.
-
What's at Stake for Alphabet as DOJ Eyes Google's ChromeAlphabet is higher Tuesday even as antitrust officials at the DOJ support forcing Google to sell its popular web browser. Here's what you need to know.
-
Six Ways to Optimize Your Charitable Giving Before Year-EndAs 2024 winds down, right now is the time to look at how you plan to handle your charitable giving. The sooner you start, the more tax-efficient you can be.
-
How Preferred Stocks Can Boost Your Retirement PortfolioHigher yields, priority on dividend payments and the potential for capital appreciation are just three reasons to consider investing in preferred stocks.
-
Structured Settlement Annuity vs Lump-Sum Payout: Which Is Better?As the use of structured settlement annuities grows, it can be tough to decide whether to take the lump sum to invest or opt instead for guaranteed payments.
-
What to Do as Soon as Your Divorce Is FinalDon't delay — getting these tasks accomplished as soon as possible can help you avoid costly consequences.
-
Many Older Adults Lack Financial Security: What Can We Do?Poor financial literacy and a lack of foresight have led to this troubling reality. It's going to take tax policy changes, education and more to address it.
-
Winning Investment Strategy: Be the Tortoise AND the HareConsider treating investing like it's both a marathon and a sprint by taking advantage of the powers of time (the tortoise) and compounding (the hare).
-
How to Fight Inflation's Hidden Threat to Your SavingsIf higher prices are putting your savings goals on hold, you're in danger of financial erosion. Fortunately, several strategies can help stop the spread.
-
10 Inefficiencies I Look for on Rich Retirees' Tax ReturnsYour tax return could hold clues to several missed opportunities and important gaps in your retirement planning.
