How Do Property Taxes on Second Homes Work?

The deadline to appeal property taxes is September in many areas. With the decline in property values, it may be worth appealing your property tax value to make sure you are paying the correct property tax amount. You may be able to save money. Josh Ritchie gives us details on how frequency of use of second properties may impact how you report property taxes.

When we think about vacation homes, taxes are rarely the issue that commands our attention. Yet while the beach out back or the stellar restaurant down the street might be more exciting to think about, taxes are a huge consideration in their own right. Failure to properly plan and budget for property taxes could transform your dream vacation home (or timeshare) from an uplifting getaway into a financial nightmare.

Here, we explore how the details of your vacation home situation affect your property tax obligations and preparation strategies.

How Frequency of Use Affects Property Taxes

Contrary to some assumptions, the government does not simply apply a blanket tax obligation to all vacation home owners. Rather, they consider how frequently the home is occupied, and whether the primary occupants are you (the owner) or tenants that you rent to.

SmartMoney helpfully divides vacation home ownership (for tax purposes) into three categories:

Use a lot, rent a lot
Rent a lot, use a little
Use a lot, rent a little

Each category is summarized and explored in more detail below.

If you use your vacation home a lot, and also rent it a lot…
Your vacation home is considered a personal residence. As SmartMoney explains, this is potentially beneficial for you:

Specifically, this applies to homes that are rented more than 14 days a year and have personal use of more than 14 days or 10% of the rental days, whichever is greater. Personal use includes use by family members and anyone else who pays less than market rental rates. Vacation homes fitting this description are considered personal residences.

“This helps you, because Uncle Sam lets you deduct interest on up to $1 million of mortgage debt (and up to an additional $100,000 for home equity loans). Property taxes are generally deductible, no matter how many homes you own. Those fortunate enough to own more than two homes can pick the two with the most mortgage interest each year which is usually the main residence and the vacation home with the biggest loan.”

The main thing to keep in mind is that you must deduct the expenses from your own use of the house and the expenses incurred while renting separately.

EXAMPLE SCENARIO:

To use SmartMoney’s example, we will assume your vacation home is rented for three months, used by your family for two, and vacant for the other seven. Vacant time, it should be clarified, is considered personal use for tax reasons. Thus, you would deduct three months worth (25%) of the interest and taxes from rental income, and nine months (75%) from your itemized deductions on Schedule A of your tax return.

Keep in mind that this category applies to “homes that are rented more than 14 days a year and have personal use of more than 14 days or 10% of the rental days, whichever is greater.”

If you rent your vacation home a lot, but only use it yourself a little…

You are treated differently for tax purposes. Specifically, the rule is that your vacation home will fall under the category of “rental properties rather than for personal residences if you rent more than 14 days a year and if your personal use doesn’t exceed 14 days or 10% of the rental days, whichever is greater.”

This scenario varies considerably from the first category. For one thing, since your home is a rental property, rather than a personal residence, you cannot deduct the interest expenses incurred during your own use. But there are benefits as well. If you incur rental losses, you can write these off as a taxable loss as long as you “actively participate” in the property by making day-to-day management decisions and meet personal income limits.

If you use your vacation home a lot, but only rent it out a little…
By far the simplest and most beneficial category, this applies to homes “that are rented for fewer than 15 days a year and used by the owner for more than 14 days.” If this describes you, then your vacation home is actually a personal residence for tax purposes. As such, you can deduct the interest and property taxes as itemized deductions, in the same manner you do for your actual home.