Tax Help - The Tax Effects of Owning A Second Home

A second home can be a house, condominium, cooperative, mobile home, house trailer or boat that has sleeping, cooking and toilet facilities. For example, an RV can qualify as a second home. If you own more than 2 homes, you must choose which home other than your main home to treat as the second home. However, you don't have to choose the same home each year.

Second Home Deductions

If you take out a mortgage to buy, construct or substantially improve a second home, the interest is deductible if you itemize deductions. Your deduction may be limited if the mortgage exceeds the fair market value of the home or if the mortgages on your main home and your second home exceed $1 million ($500,000 if you're Married Filing Separately). These limits do not apply to mortgages taken out before Oct. 14, 1987 (called grandfathered debt), but grandfathered debt reduces the $1 million and $500,000 limits.

If you take out a home equity loan or line of credit on your second home, the interest is fully deductible unless the mortgage exceeds the fair market value of the home reduced by the amount of the mortgages, including grandfathered debt, as previously described, or if the mortgages of this type on your main home and second home exceed $100,000 ($50,000 if Married Filing Separately).

Real estate taxes and points you pay over the life of a mortgage to acquire a second home are deductible if you itemize deductions. Points you pay on a mortgage to acquire a second home are also deductible over the life of the loan. If you refinance or sell the home before the mortgage is paid off, you can deduct in the year of sale or refinancing any points you didn't previously deduct.

Renting Your Second Home

If you use the home as a residence and rent it for less than 15 days during the year, you don't have to report the rental income. It's considered a residence if you (or a family member) use the home for personal purposes for more than the greater of 14 days or 10% of the number of days that you rent the home at fair rental value. You may not deduct any expenses attributable to the rental, but you may deduct interest and taxes if you itemize your deductions.

If you use the home as a residence and rent it for 15 days or more, you must report the rental income. You may deduct your interest and taxes as described above. But you can deduct other rental expenses (including depreciation) only up to the amount of the income reduced by the deductions for interest and taxes. Any rental expenses not deductible under this rule are carried to the following year, when they are again subject to this limit.

If you don't use the home as a residence, the above rules don't apply. You report your income and expenses in the same manner as for other rental property, and you can't deduct expenses other than interest, taxes and casualty losses attributable to your personal use of the home.

Selling Your Second Home

If you sell your second home, the gain will be taxed as capital gain, long-term if you owned it for more than a year and short-term if you owned it 1 year or less. A loss on the sale can't be deducted. If the second home was rented for profit, gain generally is taxed as capital gain and a loss can be deducted. The part of the gain attributable to depreciation is taxed at a maximum rate of 25%. If you used the home for personal purposes and rented it, you have to treat the sale as part personal, part business.

If the second home was your main home for at least 2 years during the 5-year period ending on the date of sale, you can exclude up to $250,000 of the gain (up to $500,000 if Married Filing Jointly and you both used the home as your main home for the required period). You can't claim the exclusion if you sold another home within the 2-year period ending on the date of sale and claimed the exclusion for that sale.

If you don't meet the 2-year ownership or use requirement, you may claim the exclusion only if you sell the home because of a change in health, place of employment, or another "unforeseen circumstance." In this situation, the maximum exclusion will be reduced. You may not exclude any gain attributable to depreciation you claimed after May 6, 1997.