Not ready to permanently move to the Charleston area but you want to purchase a second home and rent it out until you are ready?
I’ve had several clients that have done this and it makes sense, depending on your circumstances.
Interest rates are low and due to the current economy, more people are renting as they need to sell their home before they can purchase a replacement property. So, locating a tenant for your property shouldn’t be difficult, but it isn’t always guaranteed.
In addition, you’ll be able to take advantage of the generous capital gains exclusions from your taxes when you sell your primary residence, and then move into your second home and covert it into your primary residence. And, after you have lived in your now primary home (once your vacation home), for two out of the five previous years, you’ll once again be able to take advantage of the capital gain exclusions.
Every situation is different and I would enjoy discussing this further with you, if you are considering purchasing a second home in the Charleston area. I also advise to always consult with your attorney and tax advisor.
Taxes: VACATION OR SECOND HOMES
You are taxed differently on a vacation or second home in comparison to a personal residence. There are several factors in how you are taxed: the amount of time the property is rented; how long the owner occupies the premises; and the owner’s intent (i.e. is the owner holding the property for investment purposes?).
Tax rules constantly change but here is a quick summary:
-If the owner never occupies the second home, the IRS will regard it as a rental property if it is rented year round. However, if the owner never occupies the property and it is not rented, then it is considered an investment property.
-The owner is not required to report rental income if the property is rented out for less than 14 days in a year and the property is owner-occupied part-time. If this is the case, no tax deductions can be claimed for the property upkeep or expenses since no income is being reported.
-If the property is occupied by the owner for more than 14 days or 10% of the time it was rented (whichever one is greater), then the property is considered a personal residence. If the owner occupies the property to make improvements or repairs, this is not considered in the 14-day usage.
-If the property is rented out more than 14 days, all rental income must be reported. However, the owner can offset the income with deductions for expenses like maintenance, utilities, and upkeep. Also there is a depreciation deduction which can be claimed against the rental income.
The following information summarizes deductible expenses for a personal residence versus a rental property:
Deductible Expenses for a Personal Residence:
-Interest on mortgage debt, points and fees (Owners can deduct the interest paid on 1st and 2nd mortgages up to $1,000,000 in mortgage debt (the limit is $500,000 if married & filing separately)
-Taxes on real estate
-Casualty & theft losses
Deductible Expenses on Rental Property:
-Interest on mortgage debt, points and fees (Owners can deduct the interest paid on 1st and 2nd mortgages up to $1,000,000 in mortgage debt (the limit is $500,000 if married & filing separately)
-Taxes on real estate
-Casualty & theft losses
-Advertising
-Insurance
-Commissions
-Repairs, cleaning & maintenance
-Depreciation
-Tax prep fees
-Travel & local transportation expenses
The IRS website, www.irs.gov, has useful information pertaining to vacation and second-home buyers. I’ve found the following publications useful:
Publication 527, Residential Rental Property (23 page PDF): http://www.irs.gov/pub/irs-pdf/p527.pdf
Publication 544, Sales and Other Dispositions of Assets (38 page PDF): http://www.irs.gov/pub/irs-pdf/p544.pdf
Publication 925, Passive Activity and At-Risk Rules (27 page PDF): http://www.irs.gov/pub/irs-pdf/p925.pdf
Publication 946, How to Depreciate Property (a lengthy document–112 pages!): http://www.irs.gov/pub/irs-pdf/p946.pdf
The Alternative Minimum Tax might come into play, depending on your situation.
I strongly advise clients and customers to seek professional advice from a tax professional and attorney as laws constantly change and the above information might be outdated.
