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Tax Advantages of Owning a Second Home

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Adding It Up

You might think of watching TV as a passive activity, but the tax code defines passive activity as an activity in which you do not materially participate, such as real estate rentals and limited partnerships.

The trick is, rental deductions, on a vacation home, can't exceed gross rental income, less interest, taxes, and costs to advertise the property. If you rent out your beach home for 12 weeks, for instance, at $1,000 a week, your rental income will be $12,000, less the interest, taxes, and advertising costs.

If all the deductions listed earlier total more than the $12,000 of rental income received, you won't be able to list the loss (the excess expenses) on your income tax return.

If you use your vacation home as a rental property, the system changes. First of all, you can't use the home for more than 14 days or 10 percent of the time that it's rented. The second difference is that passive loss rules kick in on rental property. Passive loss is when you lose money from a passive activity, such as renting property or participating in a limited partnership.

If you lose money on your rentals—that is, if the expenses you can deduct are greater than the income from your rental property, the loss can be offset by passive income. You can claim up to $25,000 of losses in a year from vacation home rentals if your income is less than $100,000. If your income exceeds $100,000, the allowable loss decreases until income reaches $150,000, when the allowable loss is eliminated.

You also may be able to deduct the value of your rental property over a period of years. This is called depreciation, and is intended to reflect the wear and tear on a property and its contents over time. Depreciation applies to a home and its contents, but not the value of the land.

In summary, try to keep these simple rules in mind when considering possible tax advantages of owning a vacation home:

  • If you don't use the property, all your expenses are deductible against the rent.

  • If you rent the property for less than 14 days a year, the rent you receive does not have to be reported on your tax return.

  • If you use the property for more than 14 days a year, your expenses are prorated against your income.

Tax considerations shouldn't be the only reason you consider buying a vacation home. Hopefully, you'll find lots of other ways to enjoy it, too.

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Excerpted from The Complete Idiot's Guide to Personal Finance in Your 40s and 50s © 2002 by Sarah Young Fisher and Susan Shelly. All rights reserved including the right of reproduction in whole or in part in any form. Used by arrangement with Alpha Books, a member of Penguin Group (USA) Inc.

To order this book visit the Idiot's Guide web site or call 1-800-253-6476.

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