If you own a second home that you use primarily for personal purposes, IRS defines it as a vacation home. While owning a vacation home is a dream come true for many of us, it can also have some tax implications. In this article, we will discuss how the IRS defines vacation homes and how they are taxed.
What is a Vacation Home?
According to IRS guidelines, a vacation home is defined as a property that is used by its owner for personal purposes for more than the greater of 14 days or 10% of the total days it is rented to others at fair market value. It could be any type of property such as a house, apartment, condominium, mobile home or boat.
How are Vacation Homes Taxed?
If you rent out your vacation home for more than 14 days in a year and receive rental income, you will have to report it on your tax return. The rental income earned from your vacation home is taxable and must be reported on Schedule E (Form 1040). You will also have to pay taxes on any profit that you earn from renting out your vacation home.
Deductible Expenses
Similar to rental properties, expenses associated with renting out your vacation home are deductible. These expenses include:
- Mortgage interest
- Property taxes
- Insurance premiums
- Repairs and maintenance costs
- Utilities and other bills paid by the owner
However, if you use your vacation home for personal purposes for more than 14 days or over 10% of the total days rented at fair market value, then you cannot deduct all the expenses related to renting out your property. In this case, only the expenses that are proportional to the time when the property was rented can be deducted.
Capital Gains Tax
If you sell your vacation home, you may be subject to capital gains tax. Capital gains tax is calculated based on the difference between the sale price and the adjusted basis of the property. The adjusted basis is generally the original cost of the property plus any capital improvements made over time.
However, there are some exceptions to this rule. If you have owned your vacation home for at least two years and have used it as your primary residence for at least two of those years, then you may be eligible for a capital gains exclusion of up to $250,000 if you are single or up to $500,000 if you are married filing jointly.
Conclusion
Owning a vacation home can be a great investment and source of rental income. However, it’s important to understand how IRS defines vacation homes and how they are taxed. By following IRS guidelines and keeping accurate records of rental income and expenses, you can ensure that your vacation home remains a profitable investment while also staying compliant with tax laws.