August 16, 2021

With real estate prices recovering to where they were pre-2008 in most of the U.S; many people are buying U.S. vacation homes, and homes abroad for various reasons. The appeal of international vacation homes are at an all-time high as property overseas continues to cost less than near home, even in high-destination areas. A growing trend among younger Americans (Generation X and Millennials) is Co-Ownership of vacation homes versus vacation timeshares. Co-ownership is appealing to those who understand the equity benefits of owning versus renting a vacation timeshare.

The 2017 Tax Cuts and Jobs Act (The Tax Act) is helping the fuel the appeal of buying a vacation property by assisting owners in taking advantage of tax breaks. Whether investing for the equity potential or buying to enjoy the property’s benefits now, vacation properties are becoming common. But before you spend, make sure you understand the tax advantages (or disadvantages) a vacation home investment can bring:

A Vacation Home as a Rental Business: If you intend to rent out the property part of the year collecting income, you will be limited to 14 nights being tax-free income. Any additional rental days per year will need to be claimed as income, even if the property is considered a personal residence. If you have a mortgage on the property, consult your tax professional regarding what you can deduct as a rental business. Once you collect income, the IRS may determine that the property is for business use and not personal, and you may lose the second-home rules.

Your Personal Vacation Property: You can deduct mortgage interest and property taxes just as you would for personal residential property in the U.S. under the IRS’ second-home rules. Under the Tax Act, you can deduct 100% of the interest you pay up to $1.1 million of combined debt secured on your first and second home. If you use the property for income, exclusions apply. 

What about selling one property and buying a vacation property?  Understanding IRS code 1031 exchanges can make the difference between paying thousands of dollars in taxes when you sell one piece of property to buy another one, such as a vacation home.  The property must be of ‘like-kind,’ in other words a business or investment property exchanged for another business or investment property.  Because this can be complicated, you consult a tax professional if you are considering a 1031 exchange transaction.  

A sale and purchase of this type is a business transaction requiring different Tax ID numbers assigned to each property.  A qualifying exchange allows you to defer capital gains from one property if you buy a comparable property within the federal prescribed time limit.  Additionally, the property sold and the property purchased must be in one of the 50 U.S. states, with territories of the U.S. and foreign lands not included in this provision. If you’re considering a vacation property in the U.S. or a foreign country, consult a tax professional regarding taxes domestically and abroad.

Additional Disclosure: This piece is designed to provide general information on the subject covered. Pursuant to IRS Circular 230, it is not intended to provide specific legal or tax advice and cannot be used to avoid penalties or to promote, market, or recommend any tax plan or arrangement.  You are encouraged to consult per your tax advisor or attorney.

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