01/24/2010
Have you caught yourself driving around neighborhoods looking for bargain real estate to start a rental property portfolio? Or perusing the listings in your favorite vacation destinations, just on the outside hope of finding a great price on a retreat or a retirement home? I have. You know that I must spend a few days at the beach every year (it is the Southern California blood that still runs in my veins), but I’ve got to tell you that even in this depressed market, a house in Manhattan Beach or Poipu Kauai is beyond my reach – sigh. But if you aren’t searching for primo beach property (and even if you are), there are deals to be had out there and now might be the perfect time to expand your portfolio into real estate. The only pieces of advice I can offer (since I am NOT a real estate pro), is location, location, location; buy low, sell high; don’t bite off more than you can chew (fix up, mortgage, etc) :).
That said – what are the tax implications of a second home? I will tackle this in two or three installments, so stay tuned. Today – let’s keep it simple and talk about what is and isn’t deductible if you buy a second home just for you and your family to enjoy (not a rental).
• TRAVEL TO LOOK FOR A SECOND HOME. OK – I probably have your attention. If I love Kauai and want to find a second home there, can I write off the expense of looking for that home (ie air fare, hotels, rental car…on and on?)? That depends. If I am planning to move my business to Kauai for even part of the year or I’ve been offered a job there or I want a job there, then exploring the possibilities may be a little bit deductible. I don’t advise going crazy with this, however. Court cases have allowed deductions for well-documented job hunting/business exploring trips – proof of interviews, follow up phone calls/emails, contracts etc. Think in terms of travel to/from, meals and lodging on the days you are engaged in job/business endeavors – not the whole “vacation” for the whole family. Discuss with your tax pro BEFORE going on such a trip to make sure you understand the rules. Documentation is key. AND if you are simply looking for a house for a retreat, retirement, vacation – NOTHING is deductible for the house hunting trip. What if you are looking for rental property? Check back for another blog on another day for that answer.
• CLOSING COSTS AND POINTS. Almost nothing on the closing statement is currently deductible, but it is still important to give the HUD settlement sheet to your tax pro. Most closing costs get added to the basis of the house. In other words, if the house is $144,000 and the fees are $3,000, the new basis of the house is $147,000. Keep track because there will be a capital gains/loss consequence when you sell your second home. A second home is NOT a primary residence–by definition (ie “second” home). IMPORTANT: Points on the purchase of a second property are NOT deductible in the first year but must be amortized over the life of the mortgage. You can deduct seller paid points the same as regular points…BUT…you must reduce the basis of the property by the amount of the seller paid points. Of course, if you sell or refinance, the balance of the points are deductible at that time. Payments for association dues and utilities are neither deductible nor included in basis.
• MORTGAGE INTEREST. You deduct mortgage interest on your second home the same as you do your first home. It is a Schedule A itemized deduction. You can deduct ALL of your mortgage interest on up to $1.1M of debt secured by your first and second homes that was used to acquire or improve the properties (home equity debt does not have to be for improvements and cannot exceed $100K for interest deduction). That means that you can have $1.1M of mortgage debt and take a full deduction for interest. If you have more than $1.1M in debt, there is a reduction in the deductibility of the mortgage interest. THERE IS NO DEDUCTION FOR MORTGAGE INTEREST ON A THIRD PLUS HOUSE. JUST THE FIRST TWO. For UNMARRIED CO-OWNERS, the law is a little hazy, but the IRS asserts that the $1.1M limit applies to the property and not to each separate owner.
• PROPERTY TAX. Good news! You can deduct property tax on every piece of property you own. There is no “2 house” limitation. Bad news – a lot of property tax can trigger Alternative Minimum Tax (see Blog on Jan 6 2010) rendering the deduction useless. Taxes are NOT deductible for AMT.
If you find a heckuva deal close to a major and temperate body of water, let me know. We could be neighbors. But I’m not going to Florida :).