The Tax Treatment Of A Vacation House

Suppose you own a vacation house, and over the winter the wind rips off some shingles, water damages the ceilings, or a family of raccoons raises hob. Hiring an agent or other caretaker may not prevent the damage, but it will at least let you know when the damage occurred - and that's important to the IRS. Except in cases of theft, IRS rules allow casualty deductions for the calendar year the loss occurs, not for the year in which it is discovered. Damage discovered next May would be hard to date.

Casualty losses are tricky enough without further complication. They can be deducted in excess of £100 and to the extent not insured. You can deduct loss from such "sudden" events as fire, storm (including sand storm), flood, freezing, landslide, tidal wave, theft and vandalism. But you cannot deduct for losses due to insects, erosion, rusting or rot - these aren't normally "sudden" enough. Proof, too, is vital, and it is good practice to take photos promptly, gather whatever clips local newspapers may yield, and get an appraiser's statement. A prompt report of any theft or vandalism to the police will also help your case.

When a summer place is rented out, tax deductions can be taken for such non-capital items as maintenance, depreciation and insurance. The question is: How much? Recent IRS rulings and court cases point to two main rules:

If a house is rented part of the summer and occupied by the owner the rest of the season, expenses covering only the period of rental can be deducted. What's more, the deductions cannot exceed the rental income, unless it can be shown that the rental was not a casual matter and that the owner really intended to make a profit.

If a house is up for rent at the beginning of the season, and the owner does not use it at all during the summer, then he should be able to deduct full expenses for the whole renting season - even if he had a rent-paying tenant for only a few weeks.

The issue of what's deductible in a part-time rental deal was fought out - unvictoriously--by the owner of a vacation house in Sea Island, Ga. The taxpayer offered his house for rent eight months of the year, reserving it for himself during a prime four-month period. He reported rental income of £3,600 the first year, £2,400 the second, and zero the third. Yet each year he claimed deductions of £3,200 for operating costs and £4,000 for depreciation. His declared losses for tax purposes thus ranged from £4,000 to £7,500.

The IRS cut his deductions to the amount of the rent for the first two years. It allowed nothing for the third. The Tax Court affirmed the IRS position - the beach house had never been put to income-producing use within the meaning of the law. The owner not only offered it only in the off-season, but claimed maintenance expenses that would not have been covered if he had rented it the best eight months of the year. It was clear to the IRS that he was not engaged in this activity for profit, and it thus cut his deductions.

Here is an example of what the IRS considers a proper arrangement: During a three-month season, an owner rents his house for two months for £2,000. He uses it himself for one month. His year-round expenses are £1,200 for mortgage interest, £600 for real estate taxes, and £900 for maintenance and utilities. Depreciation is computed at £1,200.

The owner must first deduct the £1,800 paid out in interest and taxes (they are deductible whether he rents or not). This reduces his rental income to £200. Thus, since part-season rental is not technically considered a business activity by IRS, only £200 of all remaining expenses are deductible.

When it comes to resale of a summer property, other tax problems arise. Contrary to the common notion, any capital gain an owner makes is not wiped out if he buys another summer place within one year that rule applies only to a taxpayer's principal residence. And, any loss is normally not tax deductible, unless the property had been converted to rental use some time before the sale. But note that here, too, a part-of-the-season rental does not count. The rental period must be summer-long to qualify.


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Tax Hints For Executives On The Move

Now take a fast look at your real estate taxes. If you are selling your house and moving, there are all sorts of special services these days to assist in making a move easier. Like the service outfits (often representing real estate agents) that help you relocate in a new city.

But there's no service to help you with the tax complications of switching residences - except for your accountant and possibly the Internal Revenue Service itself. So it behoves the transferred executive (today's chronic house-jumper), the middle-aged couple seeking smaller quarters (with the kids out on their own), or the retiree going from house to apartment or condominium to bone up on real estate tax rules.... see: Tax Hints For Executives On The Move