29 Dec The tax plan and your vacation home

Q. I’m thinking of buying a vacation home. Can I deduct mortgage interest and property taxes under the new tax plan? What are the differences in tax treatment?
— Planning

A. As you know, tax laws are changing in 2018.

Among the changes is that the new laws will negatively impact the full deductibility of your property taxes.

There isn’t much of a difference between the treatment of your first home and a possible vacation home with regard to deductions under the current tax laws, said Michael Green, a certified financial planner with Wechter Feldman Wealth Management in Parsippany.

“Just like your primary residence, if you use the vacation home as a second home — rather than renting it out — interest on the mortgage is deductible within the same limits as the interest on the mortgage on your first home,” Green said.

You can write off 100 percent of the interest you pay up to $1 million of debt secured by your first and second homes or used to acquire or improve the properties.

Remember, the $1 million is a combined number that can be applied between both homes, not $1 million on each, he said.

Currently, not only are you able to deduct the property taxes on your second home, but you can deduct property taxes on an unlimited number of homes, Green said.

These rules will continue to apply when you file your 2017 tax return, but come 2019 — when you file your 2018 tax return — the new rules will take effect, he said.

“The original House proposal would have limited the mortgage interest deduction to only the interest on the first $500,000 of debt and eliminated the deduction for interest on home equity loans,” Green said. “The final version of the Tax Cuts and Jobs Act splits the difference, placing a new cap on mortgage interest deductibility on the first $750,000 of debt principal.”

It is common practice for homeowners to rent out a property during certain months to provide additional income and lower costs associated with owning a vacation home, Green said.

“However, if you rent the home out for more than 14 days in a year, you must report all income to the IRS because the house is then considered a rental property,” he said. “Even so, you get the benefit of deducting your rental property expenses.”

When the time comes to sell your vacation home – if you choose to do so – the capital gains exclusion does not apply as it does on your primary home, he said. You will be responsible for paying taxes on the full profit from the sale of your vacation home.

“A way around this is to make your vacation home your primary home before selling it,” he said. “Currently, to do this you will need to live in your vacation home for two out of the last five years.”

But this provision will also change, requiring you to live in your vacation home for five out of the last eight years.
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This post was first published in December 2017.