Ask the tax adviser
Investment property or vacation home?
Dear Tax Talk:
I wanted to start by saying your column is excellent!
I've read your answers regarding second mortgages,
vacation rentals and investment property deductions.
However, I plan to buy a condo in Hawaii, and I'm
trying to determine if there is a simple rule of thumb to follow
that says I should consider it an investment property (straight
rental) or vacation property (follow the 15 day, 10-percent rule).
I can follow the rule that would make it more advantageous for me.
That is, if I need to, I can stay in the property for the 10-percent
In terms of maximizing deductions and minimizing capital
gains from selling the property, is there generally one option better
than the other?
You certainly know how to get your question answered. Flattery
will get you everywhere!
There are two aspects to owning the home: deductions
related to owning the property and gain
on the sale. In certain cases, making the property a second
home may get you a larger current deduction than if it were a rental
In either case, the capital gain on the sale would
be taxable if the property were sold. If the property was only rental,
you could exchange it tax-free, which would not be the case if it
were a second home.
If the property were purely personal, you would get
a current tax benefit from the deduction for second-home mortgage
interest as well as property taxes. You can deduct these amounts
as itemized deductions on Schedule A generally without any limit
provided your mortgages on your first and second home are less than
If you rent the property and do not use it personally,
then you need to report the income and deductions on Schedule E.
An overall loss on the property cannot be deducted if your adjusted
gross income exceeds $150,000. A loss suspended in this fashion
is carried forward to future tax years where it is either offset
by gain on similar property or can be deducted when your AGI falls
below $150,000. Therefore, if the property is rental as opposed
to vacation, you might not receive any current tax benefit, but
the losses carry forward indefinitely. See my earlier
column for more information on loss limitations.
If the property is mixed use, such as part vacation
and part personal, you have to prorate your deductions between Schedule
A, where you get current tax benefit, and Schedule E where you may
not because of the AGI limits. Since the proration of the interest
and taxes to Schedule A is based on personal use to total use, you
may only be getting a small tax benefit from the mortgage interest
and property tax deduction, while sacrificing the ability to carry
over all losses and later do a tax-free exchange. Therefore, making
the property mixed use on purpose is probably the least attractive
-- Posted: Jan. 11, 2002