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Defining
a second home for tax-break purposes
Dear Tax Talk:
I'm interested in the treatment of and/or qualification as a "second
home" going into the 2001 tax year. I've read several articles on
the topic, and am confused by the fact that the info seems a bit
contradictory.
From the Internal Revenue Service publications
and some articles, it seems that I will be able to deduct the interest
and property taxes for the "second home" as long as I use it personally
for more than 14 days or 10 percent of the rental days per year,
whichever is greater. In an article in this site, I read that I
would have to split my interest and taxes pro-rata between Schedule
A and E (as I have no "passive income" I would get no "passive loss"
benefit).
Which is correct? I'm in the process of deciding
whether to buy a property or not.
Thanks,
David
Dear David:
Let me try to set the record straight
on the treatment of a second home for tax purposes. Let's divide
second homes into two categories: 1) never rented to others and
2) sometimes rented to others. If it is always rented to others,
then it is a rental property, and the second home rules don't matter.
If the property is never rented to others, then
the taxes and interest are deducted on Schedule A along with your
primary home's interest and taxes. The only limitation is the overall
limitations that apply to interest on home mortgage indebtedness
in excess of $1 million.
Another set of rules applies to a second home
that is sometimes rented out, since rent is taxable income. If the
property is rented out less than 14 days a year, you can ignore
the income and claim your interest and taxes as if the property
was never rented out during the year. Any other rental expenses
you pay are similarly ignored.
If you rent the property for more than 14 days
and also use the property as a residence for more than 14 days during
the year, or, if greater, more than 10 percent of the time it is
rented at fair value to others, then you run into an allocation
of expenses against the income. Your concern is that by allocating
mortgage interest and taxes against the rental income, you may exceed
the income from the property and be subject to passive loss rules.
If subject to the passive loss rules, your interest and taxes do
not produce a current tax benefit as they would if you did not have
to make the allocation.
In practice, I have found that when you are
required to allocate expenses under the vacation home rules, you
do not run into a limitation on the deduction for the interest and
taxes for two reasons. First, the interest and taxes are among the
first items allocated against the rental income. Second, most short-term
rentals of vacation homes are priced much higher than the mortgage
interest and taxes paid during the rental period. Based on this,
it is doubtful that you will run into this limitation. If, however,
you do think you may run into the limitation, you can consider increasing
your personal use of the property.
IRS Publication 527 explains the vacation home
rules.
Transferring or inheriting property: Which
is tax-preferable?
Dear Tax Talk:
My 83-year-old mother has lived with me
for over two years. We have decided to sell her home. Her home and
property is willed to me. Should we transfer title to me before
selling? What is the best tax move?
Thanks,
AE Bell
Dear AE Bell:
The property may be willed to you, but
if you transfer the property to your name, then sell it, you'll
pay income tax on any gain. Generally, anytime you make a lifetime
transfer of property to another person for less than fair value
it is considered a gift. Unlike inherited property, the cost for
tax purposes does not increase to the value at the time it is gifted.
Instead your cost in property received as a gift is the same as
that of the person who made the gift.
If the property qualifies as your mother's principal
residence, she can sell the house and exclude up to $250,000 in
gain on the sale. The house qualifies as her principal residence
if she lived in and owned the house for two of the last five years
at the time it is sold. Of course temporary absences from the home
due to medical reasons are not considered in determining if she
lived there for the two years.
When the house is sold, your mother can gift
you the proceeds, and you or she won't pay income tax as a result
of the sale (assuming she falls within the exclusion amount) and
gift. If the gift is more than $10,000, she should file a gift tax
return, Form 709.
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