Paris Pied-à-Terre FAQ :: Are payments on a fractional ownership vacation haome tax deductible?

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Are payments on a fractional ownership vacation haome tax deductible?

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© March 16, 2007 by D. Andrew Sirkin. Any reproduction or use of this document or any part of its content requires the written consent of the author. Contact Mr. Sirkin at dasirkin@earthlink.net, or visit www.andysirkin.com

Tax treatment of vacation homes depends on how often the property is used for “personal use” and how often it is used as a “rental”. There are three possible tax treatments, each with their own rules on tax deductions: “Pure Second Home”, “Pure Rental Property”, and “Second Home/Hobby Rental”.

You qualify for “Pure Second Home” tax treatment if the property is a “rental” for no more than 14 days in a particular tax year. With this tax treatment, mortgage interest and property taxes are generally tax deductible, but other expenses are not. Rent income is entirely tax free.

You qualify for “Pure Rental Property” tax treatment if both of the following two things are true: (i) the property is a “rental” for more than 14 days in a particular tax year,” and (ii) the total number of “personal use” days is either no more than 14 or no more than 10% of the total number of “rental” days. (For example, if there were 220 “rental” days, you could have up to 22 “personal use” days; if there were 100 “rental” days, you could have up to 14 “personal use” days.) With this tax treatment, you need to divide the year in two parts, “rental” and “personal use”, and allocate each expense proportionally. For the “rental” portion, expenses (including mortgage interest, property tax, insurance, maintenance, repairs, improvements, utilities, management, and even depreciation) are deductible to the extent they exceed rental income, but the deduction cannot be taken against all types of income, and in some cases must be carried forward and deducted in future years. For the “personal use” portion, only property tax is reliably deductible; other expenses, including mortgage interest, generally are not.

You qualify for “Second Home/Hobby Rental” tax treatment if you do not qualify for either of the other categories. With this tax treatment, you again need to divide the year in two parts, “rental” and “personal use”, and allocate each expense proportionally. For the “rental” portion, expenses (again including mortgage interest, property tax, insurance, maintenance, repairs, improvements, utilities, management, and even depreciation) can offset income, but are not otherwise deductible. For the “personal use” portion, mortgage interest and property taxes are generally deductible, but other expenses are not.

When determining how often the property is used for “personal use” and how often it is used as a
“rental”, these rules apply:

Use by a co-owner, even when the co-owner pays a usage fee, is “personal use”.
Use by a relative of an owner, even if the relative pays full rent, is “personal use”.
Use by a non-owner under a vacation home exchange or swap arrangement is “personal use”.
Days spent primarily repairing or maintaining the vacation home are not “personal use”, but need not be counted as “rental” days either.
A day when the home is available for rent but is not actually rented cannot be counted as a “rental” day.

When vacation property is co-owned, IRS Regulations seem to contemplate that usage of all the co- owners (and their relatives, non-paying friends, and swappers) should be added together to determine the total number of “personal use” days, and the days when the property was rented to paying tenants who are not owners or relatives (regardless of whether the rent went to an individual owner or was shared by the group) should be added together to determine the total number of “rental” days. The tax treatment should then be determined. If the home qualifies as a Pure Second Home, each owner can then generally deduct all of the mortgage interest and property tax he/she paid. If the home does not qualify as a Pure Second Home, the group will need to determine the collective “rental”/”personal use” expense allocation ratio. Each owner will then need to apply that ratio to the expenses he/she has paid, offset any income he/she received, and apply the appropriate tax deduction rules as outlined above.

Nevertheless, at least one article that explores this topic in detail has concluded that this approach may not be either workable or fair in practice, and that it would be reasonable for each owner to determine his/her tax treatment separately based on his/her usage and rental of his/her interval.

This discussion of tax issues is intended as an introduction to the general rules only. You should consult a qualified attorney or accountant for complete and personalized tax information.

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