Why buy one home and deduct a small amount of mortgage interest, when you can buy two homes and deduct double the amount of mortgage interest? A not-so-well-known rule exists regarding second homes.
Most people focus on one home, their first home, also known as their primary residence. Many tax and investment advantages are utilized because of a primary residence. For the most part, real estate tends to rise over time, making it a fair and stable investment. Mortgage interest is deductible on Schedule A of the Individual Form 1040. Insurance and taxes are deductible as well. Once the primary residence is paid for in full, it is a dwelling in which the resident can live rent and mortgage free, freeing up the available cash for other investments such as stocks, bonds, and closely held business ventures. Further, when the primary residence is sold, the gain is excludible up to $500,000 tax free under section 121 of the Internal Revenue Code. A primary residence, despite the recent drawback in value for real estate, stands as a good investment.
A Second Residence
To quote the Internal Revenue Code, “Whether property is a residence shall be based upon all the facts and circumstances, including the good faith of the taxpayer. A residence generally includes a house, condominium, mobile home, boat, or house trailer that contains sleeping space, toilet and cooking facilities. A residence does not include personal property such as furniture or a television, that in accordance with the applicable local law, is not a fixture.”
A second home also has its advantages. Any dwelling with a kitchen facility, sleeping accommodations, and a washroom qualifies as a second residence for tax purposes. Second homes are eligible for interest and tax deductions as well. For the boater, this deduction is a windfall. Not only does the boater get to deduct the value of their house, but their boat as well. Most boats 25 feet in length qualify for second home treatment. While portable toilets generally don’t qualify, those with installed “heads” fit the rule. As far as a galley area is concerned look for more than a microwave to justify the galley requirement. An installed stove of gas or alcohol fuel fits nicely. As far as sleeping quarters, most boats 25 feet in length with an enclosed cabin and a front birth will suffice under the definition. Bringing all the comforts of home is not only necessary for creature comfort, but carries tax advantages as well being a second home.
A decade ago, there used to be a lot of controversy as to whether vacation homes were considered personal property or business property capable of being properly exchanged in a Section 1031, like–kind exchange. There was the argument that because they are used for personal use, they did not qualify. On the other hand, there was the argument that because this asset is a capital asset and subject to capital gains, it is by default an asset subject to 1031 deferral. Fortunately, as of 2006, the tax law made this more clear. If the property is rented for 14 for 14 days or more per tax year, the asset qualifies for like-kind exchange. If the asset is being used 13 days or less, it does not qualify as a like-kind asset. There is now a relatively clear answer to vacation homes and their existence. Remember interest and taxes, together with all operating expenses are deductible if the 14 day rule applies.
Many people invest their extra money in stocks, retirement accounts, CD’s and other worthwhile endeavors. In America, we have the opportunity to purchase second homes. Whether they are a permanent structure on land, drive over highways, or float on water, they qualify for mortgage interest deduction if they have washroom, kitchen, and bedding facilities. Not only does the taxpayer get to own the assets and enjoy them with their families and clients, they get to enjoy financial and tax advantages as well. Anyone desiring a second home would be well advised to consider the purchase seriously.
By: Dr. Bart Basi at the Center for Financial, Legal and Tax Planning for Transworld M&A Advisors