The value of vacation properties, like the value of principal residences, has fallen on average by 25% in this dismal housing market. The number of sales has plummeted as potential buyers are squeezed in a tough economy by stock market declines and fears of job loss. Also, there are no government incentives for buyers to purchase vacation property (the first-time homebuyer credit applies only to buying a principal residence). If you already own a vacation home but are finding the financial burden too steep today, what can you do? Here are some tax breaks to ease the cost of ownership. You might also considering renting or selling the vacation home.
You can deduct certain costs related to ownership of vacation property if you itemize deductions:
Even in a tough economy, well-situated vacation homes-near beachfront, ski slopes, or other desirable locations-can still bring in cash. This money can be used to cover the insurance, taxes, and other costs of ownership of the vacation home; it may even produce positive cash flow in the right circumstances.
The amount of time you (and family members) use your home and the days it’s rented to others at a fair rent determine your tax breaks:
If you’ve owned the vacation property for years, a sale may still generate a profit in this tight real estate market. Taxwise, any gain on the sale of a vacation home doesn’t qualify for the home sale exclusion; the exclusion of $250,000 ($500,000 on a joint return) applies only to a principal residence.
If you previously used a vacation home that you now use as your principal residence, you can qualify for the exclusion if you’ve owned and lived in the home for at least 2 years prior to the date of sale. However, the exclusion does not apply to any gain related to “nonqualified use.” Nonqualified use means using the residence as a vacation home after 2008. Thus, if you use the vacation home for all of 2009 and start using it as your principal residence on January 1, 2010, a sale after January 1, 2012 (when the two-year rule is met) can qualify for the exclusion, but not the portion of gain related to the nonqualified use in 2009.
Tax-free exchange. If you can’t claim the exclusion for any reason (it is still your vacation property), you may be able to postpone reporting the gain by trading the property for other vacation property. Under the like-kind exchange rules, a trade qualifies if both the property relinquished and the newly acquired property are held for investment. Thus, you’ll have to show that both the old and replacement property are being used as investment properties (e.g., rented out for a minimum period).
There is a safe harbor under which the IRS will not challenge whether a dwelling unit qualifies as investment property for purposes of the like-kind exchange rules. The properties are considered investment property if three conditions are met: (1) each property is owned for at least 24 months, (2) the owner rents the property at a fair rental for 14 days or more during those 24 months before and 24 months after the trade, and (3) the homeowner’s personal use does not exceed 14 days or 10% of the number of rental days during a 12-month period (for each of the two 12-months prior to the trade and two 12-month periods after the trade).
Sale at a loss: If you sell your vacation home at a loss, you cannot deduct the loss. No write-off is allowed for a loss on a personal asset.
Foreclosure. If you default on the mortgage and your lender forecloses on your vacation home, forgiving any remaining mortgage balance, you are taxed on this debt forgiveness. The break for cancellation of debt income applies only to a principal residence and not to vacation property.
A tax technique for receiving a refund of back taxes by applying a deduction or credit from a current tax year to a prior tax year. For example, a business net operating loss may be carried back for two years.