Can’t Deduct Vacation Home Property Taxes?

Consider Renting It.

 

The recently enacted Tax Cuts and Jobs Act of 2017 imposed harsh limitations on the federal deductibility of state and local taxes.
 

Beginning in 2018, the aggregate maximum amount of state and local taxes that may be deducted in any year (other than such taxes attributable to a business or real estate rented more than 14 days) is $10,000.
 

Taxpayers residing in states with high income and property taxes could therefore lose the ability to deduct their property taxes entirely, particularly their property taxes on a second residence used as a vacation home.
 

For example, assume H’s and W’s primary residence is in a high-income tax state and municipality with high property taxes. In addition to their primary residence, they also own a vacation home with annual property taxes of $12,000 that they use 14 weekends (28 days) every summer.
 

Their combined state income tax and property tax on their primary residence exceed $10K, thereby rendering the property taxes on the vacation home nondeductible. Assuming they are in the highest tax bracket, the loss of the deduction results in a lost tax saving of $4,400 ($12,000 x 37%).
 

But given the right circumstances, by renting out the vacation home under either of the 2 following scenarios, H and W can potentially recoup all or a sizable portion of the tax benefits otherwise lost:

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Scenario 1: Rent the vacation home for no more than 14 days and receive the rental income on a tax-free basis. Assuming H and W can rent the vacation home for at least $2,200 per week, they will fully recover the lost tax savings and will obviously come out ahead if they can rent it for more than that.
 

Scenario 2: Rent the vacation home for more than 14 days for additional taxable income. This will allow a portion of the $12,000 in property taxes to be deducted against the taxable rental income. The extent to which the property taxes can be so used is based on a fraction, the numerator of which is the number of days the property is rented and the denominator of which is the sum total of rental days and personal use by H and W. So the less personal use by H and W relative to the rental use, the greater the percentage of the $12,000 in property taxes that can be deducted against the rental income. If H and W in the example were to rent the vacation home for 21 days, then 43% (21/49) of the property taxes, or $5,160, can be deducted against the rental income.

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There are some caveats to the deduction under Scenario 2. Under special rules for residences that are both personally used and rented for more than 14 days, the property taxes allocated to rental use generally cannot be deducted in excess of the rental income to create a tax loss; however, this limitation will not apply if H’s and W’s personal use of the home does not exceed the greater of 14 days or 10% of the days it is rented.

Additionally, if H and W were to later convert the vacation home to their principal residence, renting the vacation home under Scenario 2 may result in a reduction in the $500K gain exclusion if the home is later sold. Taxpayers contemplating this option should consult with their tax advisor before proceeding

 

If you are interested in learning how to take advantage of the changes in the new tax bill and set yourself up for retirement you can attend one of our FREE private briefings.

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DISCLAIMER: This memorandum was produced by Summit Financial Resources, Inc. Securities and investment advisory services are offered through Summit Equities, Inc. Member FINRA/SIPC. Financial planning services are offered through Summit Financial Resources, Inc. 4 Campus Drive, Parsippany, NJ 07054. Tel. 973-285-3600 Fax. 973- 285-3666. This memorandum is for your information and guidance and is not intended as legal or tax advice. Legal and/or tax counsel should be consulted before any action is taken. 20180608-537