News
12-07-2006, 04:18 PM
Figuring the Tax Benefits of Renting
By AMY GUNDERSON
Published: November 15, 2006
Morphing a vacation home into an income-generating rental property can mean taking on an extensive to-do list. But along with all the tasks that go into the general maintenance of the property, homeowners have one more thing to deal with: Uncle Sam.
The decision to turn a second home into a rental, whether for a few prime vacation weeks a year or for several months throughout the winter ski season, has several tax benefits (think writing off the cost of that new water heater) beyond the standard perks of deducting mortgage interest and property taxes. But do not start gathering Home Depot receipts yet. Qualifying for these additional tax benefits depends largely on income and, most important, on how often a property owner might use the home.
In fact, figuring out the potential tax implications will affect the decision on whether and how often a property owner will want to rent out the home, said Barbara Steinmetz, a certified financial planner in Burlingame, Calif. “I give my clients the good, the bad and the ugly,” she said. Here is a look at three types of second homeowners and the potential tax breaks and pitfalls that come along with becoming a landlord.
Rarely Rented
HOMEOWNER: Uses ski condo primarily for own purposes and only rents it out for a week in December.
TAX IMPLICATIONS: This is the most straightforward scenario. If a vacation house is rented out for less than 15 days each year, the rental income does not have to be reported. While the house can still qualify for the mortgage interest, property tax deductions and write offs for casualty and theft losses, in this tax category, a property owner cannot deduct any other expenses associated with operating and maintaining the house.
Frequently Rented, but Rarely Used by the Owner
HOMEOWNER: Visits a beach house for just a single prime week in August, while the rest of the summer and fall the house sees plenty of foot traffic from renters.
TAX IMPLICATIONS : Since the property is rented out for 15 days or more, that rental income will have to be reported. But these homeowners are now qualified to deduct expenses associated with maintaining the house and marketing it to renters. Everything from utilities, cable television, commissions paid to a property manager and insurance may be deducted. The cost of basic home repairs, like fixing a broken window, may be deducted, and larger home improvements, anything that “extends the life of the house,” said Greg Rosica, a partner at Ernst & Young, may also be depreciated over several years.
The I.R.S. sets the usage bar at 14 days or 10 percent of the number of days a property was leased out at fair market value as the maximum amount of time at which a property owner may take a loss. Say that $25,000 in annual rental income meant $30,000 in home maintenance, improvements and other expenses, a homeowner may take a $5,000 loss on that property.
But for homeowners making more than $150,000, “They are not going to be able to write it off because they make too much money,” said Dave Bergman, a certified financial planner in Marina del Rey, Calif. Instead the loss goes into what the I.R.S. dictates as a “suspended loss,” Mr. Bergman said. However, once the rental property starts turning a profit, a homeownermay take advantage of the losses incurred years ago. “It’s a deferred tax benefit,” he said.
If a homeowner makes a profit on the property with its sale, but has been depreciating the house, that homeowner should expect a 25 percent tax bill, regardless of whether they have been taking a loss on the property or not. It is the I.R.S.’s way of saying, Mr. Bergman said, “this was your business renting out real estate, you were depreciating the business because of abuse and wear and tear on the property and now you have made a profit on the sale, so we are going to tax you at a higher rate.”
Frequently Rented and Used by the Owner
HOMEOWNER: Rents out a mountain cabin for three months of the year but uses it the entire month of November.
TAX IMPLICATIONS: The property owner will have to report the rental income and may deduct the expenses associated with operating the house as a rental, but because it was used for more than 14 days, the I.R.S. does not allow the property owner to write off more than the value of the annual rental income. In short, that homeowner cannot take a loss on the property.
But not all of the days a property owner spends at the house have to count toward personal use.
“If you are there for a week and for six of those days you are going to fix up the property, then those days don’t count as personal use,” Mr. Rosica said.
Not only can those days spent working on the house and meeting with local property managers not count as personal use, but travel expenses to the property, from filling up the gas tank to airline tickets, can qualify as deductible expenses. “The trip to China to buy Oriental rugs to furnish the house might get called in to question,” said Mark Luscombe, a principle analyst at CCH, a tax information firm.
The best advice for property owners is to keep good records. “If you want to qualify it for rental activity, keep a log that lays out how many days you were there so you can say, ‘here is the Home Depot receipt for the hot water heater and here is a list that lays out what I did each day in terms of repairs,’ ” Mr. Bergman said. “Keep anything that can help to substantiate your trip there.”
And find a good accountant.
By AMY GUNDERSON
Published: November 15, 2006
Morphing a vacation home into an income-generating rental property can mean taking on an extensive to-do list. But along with all the tasks that go into the general maintenance of the property, homeowners have one more thing to deal with: Uncle Sam.
The decision to turn a second home into a rental, whether for a few prime vacation weeks a year or for several months throughout the winter ski season, has several tax benefits (think writing off the cost of that new water heater) beyond the standard perks of deducting mortgage interest and property taxes. But do not start gathering Home Depot receipts yet. Qualifying for these additional tax benefits depends largely on income and, most important, on how often a property owner might use the home.
In fact, figuring out the potential tax implications will affect the decision on whether and how often a property owner will want to rent out the home, said Barbara Steinmetz, a certified financial planner in Burlingame, Calif. “I give my clients the good, the bad and the ugly,” she said. Here is a look at three types of second homeowners and the potential tax breaks and pitfalls that come along with becoming a landlord.
Rarely Rented
HOMEOWNER: Uses ski condo primarily for own purposes and only rents it out for a week in December.
TAX IMPLICATIONS: This is the most straightforward scenario. If a vacation house is rented out for less than 15 days each year, the rental income does not have to be reported. While the house can still qualify for the mortgage interest, property tax deductions and write offs for casualty and theft losses, in this tax category, a property owner cannot deduct any other expenses associated with operating and maintaining the house.
Frequently Rented, but Rarely Used by the Owner
HOMEOWNER: Visits a beach house for just a single prime week in August, while the rest of the summer and fall the house sees plenty of foot traffic from renters.
TAX IMPLICATIONS : Since the property is rented out for 15 days or more, that rental income will have to be reported. But these homeowners are now qualified to deduct expenses associated with maintaining the house and marketing it to renters. Everything from utilities, cable television, commissions paid to a property manager and insurance may be deducted. The cost of basic home repairs, like fixing a broken window, may be deducted, and larger home improvements, anything that “extends the life of the house,” said Greg Rosica, a partner at Ernst & Young, may also be depreciated over several years.
The I.R.S. sets the usage bar at 14 days or 10 percent of the number of days a property was leased out at fair market value as the maximum amount of time at which a property owner may take a loss. Say that $25,000 in annual rental income meant $30,000 in home maintenance, improvements and other expenses, a homeowner may take a $5,000 loss on that property.
But for homeowners making more than $150,000, “They are not going to be able to write it off because they make too much money,” said Dave Bergman, a certified financial planner in Marina del Rey, Calif. Instead the loss goes into what the I.R.S. dictates as a “suspended loss,” Mr. Bergman said. However, once the rental property starts turning a profit, a homeownermay take advantage of the losses incurred years ago. “It’s a deferred tax benefit,” he said.
If a homeowner makes a profit on the property with its sale, but has been depreciating the house, that homeowner should expect a 25 percent tax bill, regardless of whether they have been taking a loss on the property or not. It is the I.R.S.’s way of saying, Mr. Bergman said, “this was your business renting out real estate, you were depreciating the business because of abuse and wear and tear on the property and now you have made a profit on the sale, so we are going to tax you at a higher rate.”
Frequently Rented and Used by the Owner
HOMEOWNER: Rents out a mountain cabin for three months of the year but uses it the entire month of November.
TAX IMPLICATIONS: The property owner will have to report the rental income and may deduct the expenses associated with operating the house as a rental, but because it was used for more than 14 days, the I.R.S. does not allow the property owner to write off more than the value of the annual rental income. In short, that homeowner cannot take a loss on the property.
But not all of the days a property owner spends at the house have to count toward personal use.
“If you are there for a week and for six of those days you are going to fix up the property, then those days don’t count as personal use,” Mr. Rosica said.
Not only can those days spent working on the house and meeting with local property managers not count as personal use, but travel expenses to the property, from filling up the gas tank to airline tickets, can qualify as deductible expenses. “The trip to China to buy Oriental rugs to furnish the house might get called in to question,” said Mark Luscombe, a principle analyst at CCH, a tax information firm.
The best advice for property owners is to keep good records. “If you want to qualify it for rental activity, keep a log that lays out how many days you were there so you can say, ‘here is the Home Depot receipt for the hot water heater and here is a list that lays out what I did each day in terms of repairs,’ ” Mr. Bergman said. “Keep anything that can help to substantiate your trip there.”
And find a good accountant.