In this week’s case study, the “Money Talks” hosts take a look at a complicated but common problem for many taxpayers: a mixed-use second home. Generally, taxpayers are allowed to deduct interest on debt used to buy, build or substantially improve both a first and second home. This is limited to an overall $1.1 million in total mortgage indebtedness for a couple that is married and filing jointly.
However, your taxes become more complicated when you begin renting your home. What drives the tax treatment of a home is days of personal use—not a dollar amount. You can consider your home a personal residence if you use it for personal purposes during the tax year for more than the greater of 14 days or 10% of the total days you rent it to others. When you have a mixed-use home, you should allocate your expenses between personal and investment use. The personal use portion of mortgage interest and taxes may be deductible on Schedule A. The balance of those plus allocable expenses such as maintenance, insurance, travel and advertising costs are reported on Schedule E (Supplemental Income and Loss) for a rental property. These expenses can offset income but cannot go below zero to create a loss for a mixed-use property with substantial personal use. There is also a special rule for renting personal residences: If you rent your home for fewer than 15 days, you do not need to report any of the rental income nor can you deduct any expenses as rental expenses.
Complicating rental income further, the amount of rental losses you can write off is phased out for modified adjusted gross income (MAGI) between $100,000 and $150,000. A taxpayer may deduct up to $25,000 in rental real estate losses as long as the taxpayer actively participates and MAGI is less than $100,000. If your MAGI is more than $150,000, you cannot use a loss on Schedule E to offset regular income; however, the losses carry forward and can be used either when income falls below the threshold or when you sell the property.
In any case, you’ll also want to keep detailed records of your rental losses, money spent on the property, and costs associated when selling the property, such as closing costs and transfer taxes. All of these can be used to offset the gain on the property.
Needless to say there isn’t a simple rule of thumb to use when calculating income and deductions on a mixed-use property. By working with a tax adviser, you can manage your personal use of the house to gain the best allowable tax advantage. And keep in mind, almost all properties require maintenance and repairs. Days spent at the home during maintenance projects are not considered personal use.
Income taxes are complicated to begin with, and mixed-use properties complicate taxes even more, even though rental properties and second homes are very common. Having a good tax adviser can help ensure you are using the property in the most tax advantageous way. If you have questions on how your second home affects your taxes, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
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