A vacation home is usually a property where you plan to spend a significant amount of time away from your primary residence. Many people use their second home for recreational purposes, as a way to fold into their lives something that they otherwise can’t get – a peaceful rural setting, a nearby golf course, a mountain slope for skiing and summer recreation, a lakefront view, or an Oceanside retreat. Some people buy a vacation home for the future, as a place to which they plan to retire. Some rent it out when it is not in use, helping to subsidize the cost of owning and maintaining it. Buy by definition, a vacation home is not a rental property – it is used primarily by the owner. If you own vacation property and rent it out for less than fourteen days, you are allowed to treat the property as if it were a primary residence for tax purposes. Since a vacation home generates a negative cash flow for most owners (the expense of ownership almost always exceed any rental income it brings in), you will be able to deduct property and mortgage interest. You are allowed to deduct the interest associated with the first $1 million of debt used to purchase, build, or improve your principal residence and one vacation home. These deductions, however, are reduced for high-income taxpayers, as with any deduction. At a certain income level, the IRS no longer permits you 100 percent of itemized deductions; it begins a small phase-out of these deductions – including mortgage interest. (Please see your accountant for more information). If you do not rent out your vacation home for more than fourteen days per year, you pay no tax on rental income. However, you cannot deduct rental expenses.

If you rent your vacation home for more than fourteen days per year, you have to treat your second home as rental property for tax purposes. The rental income less expenses and depreciation must be included in your taxable income. However, you may deduct property taxes and mortgage interest and all other rental expenses associated with the property, including depreciation. To the extent that rental expenses are not deductible in the year they are incurred, they can be carried forward to future years.

More and more households look to rent their vacation property to help defray costs. With vacation property values rising, this rental strategy makes sense. Nonetheless, for most vacation properties, particularly in the “hot” vacation locations, rental income will likely not cover your property expenses (including mortgage payments). One alternative is to look for a vacation property in a less desirable, less expensive market. You may not have to rent your property as many weeks per year in a less expensive area for you to be able to financially carry the property.