By: Steven D. Hamilton, Principal, Steven D. Hamilton, CPA

June 26, 2015 7:53 pm EDT
Tennessee lake

Someone asked me during the busy season how I came up with the topics for my articles.

It is whatever catches the eye of a somewhat-ADD 30-year tax CPA.  We are a bit of a garage tax compendium, I guess.

What caught my eye this week was another case concerning rental property. It gives us a chance to talk about the “vacation home” rules. If you have a second home, odds are good that you and your tax preparer have talked about these rules.

Let’s say that a person – let’s call him Steve – buys a second home. It is in Tennessee. Steve likes Tennessee.

There are three things that Steve can do with his home in Tennessee:

(1) It can be a true second home. Steve, Mrs. Steve and Steve-descendants use it whenever they can. No non-Steves use the home.

(2)  It can be rented. Steve never uses it, as it is being rented to non-Steves.

(3)  Steve uses it some and rents it some.

It is (3) that drags us into the vacation home rules.

Let’s recall what the tax difference is between owning a house as a primary residence and owning it as a rental:

(1) Primary residence – you can deduct…

a. Mortgage interest

b. Real estate taxes

(2) Rental – you can deduct…

a. Mortgage interest

b. Real estate taxes

c. Operating costs, such as utilities and insurance

d. Maintenance costs, such as mowing in the summer and snow removal in the winter

e. Depreciation

As you can see, there is a wider range of potential tax deductions if only we can qualify Tennessee as a rental.

Congress and the IRS know this. That is how we got the vacation home rules to begin with. You cannot rent out the place one week out of year, use it personally the rest of the time and deduct everything that is not tied down.

Our Code section is 280A and it is a math quiz:

(1) Did you rent the place for less than 15 days during the year?

(2) If no …

a. Did you use it personally less than 10% of the days it was rented out?

Let’s go through it.

(1) If you rent the place for two weeks or less, the rental income is not taxable. Mortgage interest and real estate taxes are deductible the same as a residence.

COMMENT: Makes no sense, right? The IRS is actually letting you NOT REPORT income? How did that get in there? I bet it has something to do with Augusta and the Masters. It helps to know people who know people.

(2) You rent it out more than two weeks and use it more than 10% of the rental days.

Congratulations, you have a second home. You also have rental income. You have to report the rental income, but the IRS is kind enough to allow you to take rental deductions UP TO A POINT. You cannot claim so many deductions that you reach the point of a tax loss. You must stop at zero

The deductions get allocated between the personal use days and the rental use days. It’s only fair.

Since it is a second home, you get to deduct whatever interest and taxes were not allocated to the rental as personal mortgage interest and personal real estate taxes.

(3) You rent it out more than two weeks and use it less than 10% of the rental days.

You still have to allocate the expenses as we discussed in (2), but the IRS now allows you to claim a rental loss. Why? Because at less than 10% personal use the IRS does NOT consider this to be your second home. The IRS considers it a rental.

There is a downside, though. You know that mortgage interest allocated to the personal use? It is not deductible anymore. Why? Because the only thing that made it deductible before was that it was attached to your second home.  As we said, under scenario (3) the IRS considers this to be a rental, meaning it is not your second home.

You do get to deduct the real estate taxes allocated to the personal use. Taxes have a different tax treatment.

There are some special rules on counting days. For example, days spent repairing or maintaining the property do not count, either as personal use or as rental. You might want to document these days well, though.

What if Steve wants to allow Steve-descendants to use the place?

Most of the time this will not work. The reason is that Steve-descendants are considered to be Steve, and that means personal use days.

But there is small exception…

Steve-descendants will not be considered to be Steve if:

  • They pay fair market rent, and
  • They use the place as their principal residence

It is the second requirement that causes the problem. Put the house in Hilton Head or Key West and odds are that no one is using the place as a principal residence.

However, put a Steve-descendant into medical school in Tennessee and you may have the beginnings of a tax plan.

Our case this week is Cheryl Savello v Commissioner. She had more than one thing going, but our interest is whether she got to treat a Nevada property where her daughters stayed as rental property.

Her daughters used the place as their principal residence.

The Court agreed that the rent appeared to be market value, citing offers to rent from third parties.

But the Court decided that there was no rental. The daughters’ use was attributable to their mother.

What happened?

Her daughters didn’t pay the rent.

The views and opinions expressed herein are those of the author(s). Core Compass’s Terms Of Use applies.

About the author

Steven D. Hamilton is a career CPA, with extensive experience involving all aspects of tax practice, including sophisticated income tax planning and handling of tax controversy matters for closely-held businesses and high-income individuals.

IRC Section 280Asecond homesvacation homerental property
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