Based on a survey done by Statista in the fall of 2018, almost 15% of Americans surveyed said yes when asked if they owned a second home. This likely comes as no surprise to those of us that live in cabin country and among snowbirds who flock to somewhere warmer at the first frost. If you already own a second home or are thinking about purchasing another property, here are some tax considerations of a second home:
Deduction of real estate taxes
The limitation on deductible state and local taxes is $10,000 per the Tax Cuts and Jobs Act of 2017. If you pay $35,000 of state income taxes on your wages, $4,000 of real estate taxes on your primary residence and $2,500 of real estate taxes on your cabin, only $10,000 of the total $41,500 paid will be deductible. However, that only comes in to play if you itemize deductions. Married couples get a $24,000 standard deduction. The Tax Foundation estimates the standard deduction will be higher than itemized deductions for almost 90% of American taxpayers in 2018.
Another change from the Tax Cuts and Jobs Act of 2017 involved the deduction of mortgage interest. Taxpayers are now only able to deduct mortgage interest on the first $750,000 of indebtedness incurred after December 15, 2017. Interest rates are still historically low so many people are acquiring a second property via debt financing while also carrying a mortgage on their primary residence. Again, the mortgage interest deduction only comes in to play for people who itemize their deductions.
Renting out the property
The rules related to reporting rental property income and deducting costs vary based on the amount of personal and rental use. If renting out your second home is highly likely, consult with your CPA prior to starting any rental arrangements. Discuss estimates of rental days and personal days. Also, get a sense of how that will affect the income you have to report and deductible expenses. Furthermore, consider the liability exposure you may now have with renters using your property. Explore risk mitigation options with your trusted advisors.
If your two properties are in different states, take the time to educate yourself on the residency rules in both locations. This is especially important if the states have a significant disparity in income taxes rates (ex. 9.85% is the highest income tax rate in Minnesota vs. 0% in Florida). People often establish residency in the lower tax state. However, this can be an involved process and the other state might challenge the validity of the stated residency. The item most often contested is where you spent your days. Several apps exist that can track that for you automatically using your phone’s GPS.
Selling the property
Many people are familiar with the gain exclusion of $250,000 ($500,000 for married couples) on the sale of a primary residence. Second properties do not receive the benefit of a similar exclusion. There are some options to reduce or defer the gain. However, anyone purchasing a second property should be prepared to recognize a capital gain on the eventual sale. Renting and depreciating the property can also add complexity when computing the final gain.
Rarely do these tax considerations of a second home hold our clients back from purchasing a family cabin or a retirement condo. That being said, it’s always better to go in to a significant purchase with eyes wide open.
Laura Bereiter, CPA, CFP® joined White Oaks Wealth Advisors in October 2015. She offers comprehensive wealth, tax, and estate planning to the firm’s clients.