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George Saenz, the Bankrate.com Tax Talk columnistSecond home vs. rental property

Dear Tax Talk,
My question deals with residential rental property. I bought a house with the intention of living in it but changed my plans and rented it out for the first six months of the year. I never did live in the house at all.

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After the first six months, the lessee moved out. I am still actively trying to rent it out, but have had no luck doing so. What are the tax implications of this?

My rental expenses are greater than my rental income and my income is over $150,000. Will the rental loss have to be carried forward? What about the real estate taxes and mortgage interest? Can they be deducted on Schedule A or do they have to be included as rental expenses on Schedule E?
-- Jason C

Dear Jason,
Well, as you already seem to know, if your AGI (adjusted gross income) is greater than $150,000 you cannot claim a current loss from rental property against other income such as salary and investment income. Instead the loss is suspended and carried forward until a year in which your income drops below $150,000 or you have rental income or gains from the sale of rental property.

If instead of being treated as rental property, the property were considered a second home, you could claim the mortgage interest and taxes on Schedule A as a current deduction. Therefore you need to know the difference between a second home and a rental property.

Interest on a second home is a Schedule A deduction if it is a qualified home. If you have a second home and rent it out part of the year, you also must use it as a home during the year for it to be a qualified home. You must use this home more than 14 days or more than 10 percent of the number of days during the year that the home is rented at a fair rental, whichever is longer. If you do not use the home long enough, it is considered rental property and not a second home and you would deduct the expenses on Schedule E.

Therefore, you must use the property before the end of the year to shift the interest and tax deductions for the nonrental period to Schedule A. However, if the property is appreciating in value, it may make more sense to just carry over the loss until the year you sell it.

To ask a question on Tax Talk, go to the "Ask the Experts" page, and select "taxes" as the topic.

Bankrate.com's corrections policy -- Posted: Sept. 5, 2006
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