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Federal tax provisions affecting residential real estate are being reviewed for possible cuts. The National Association of Realtors has recently defended the tax deductions associated with home ownership in testimony before the U.S. House Ways and Means Committee.
Tax deductions make home ownership financially attractive. New tax laws provide updated guidelines on mortgage availability and regulations on lenders. These and other benefits have helped increase the purchase rate of “second” homes. But as tax laws continue to change, homebuyers may need to more carefully consider the tax consequences of their purchase.
Nationally, about one third of home purchases today are for second homes. Second homes are most often purchased as an investment, a vacation home, or a rental property.
Real estate professionals say more homeowners today are purchasing a home for their elderly parents or their adult children who cannot otherwise afford to pay for a home during the economic downturn. These relatives may have few or no resources of their own to make down payments or pay for home repairs. Some may pay rent and/or utilities for the residence.
Should you consider purchasing a second home, there are tax advantages and a few warnings.
First, a warning: there’s a potential pitfall for higher income
taxpayers who are subject to the alternative minimum tax (AMT). Those who must pay AMT cannot deduct real
estate taxes, they must pay tax on any gain on the sale of the property, and
should there be a loss on the sale of the property later, the loss is not
deductible.
There are several tax deduction benefits though, that make the purchase of a second home attractive, such as:
Mortgage interest: Mortgage interest paid on a loan used to finance the price of the purchase, improvements made to the home, or the building of a second home is typically 100 percent deductible, just as it is on a primary residence.
Rental income: If you rent the property no more than 14 days a year, you can pocket the rental income tax free. If you rent the property for more than 14 days you must report all rental income, but you can deduct a portion of the mortgage interest, property taxes, insurance premiums, utilities and other rental expenses.
Investment: If you buy a property and expect that you may sell it again when property values go up, you are allowed to earn a certain amount of profit tax free. But the practice is not as lucrative as it used to be. Congress has changed the tax law to give the greater benefit to those who have lived in the second house for a time as a permanent residence before they sell it. Tax rules on losses have also changed; though losses collectively over time may be deducted from taxable profit when you sell the property.
As you review the financial considerations, remember that much of the tax benefit depends upon how high your overall income is and how much you may use the property yourself.
Each taxpayer’s story is unique, so the purchase of a second home should be deliberated carefully and with the assistance of not only a real estate professional, but also a tax professional you trust. For more information, contact us at McRuer CPAs.
