A vacation home refers to a secondary dwelling that the owner uses for recreational purposes such as vacations and holidays. Generally, a vacation home is located in a different place away from the primary residence, and it is used for a few days or weeks in a year.
When not in use, the vacation home can be rented to earn additional income. Vacation homes are different from investment properties that are purchased or constructed to generate rental income and profit from capital gains from the sale of the property.
Vacation homes are subject to a different tax treatment from rental properties. Depending on the property’s location and how the second home is used, the U.S. Internal Revenue Service may categorize the home as a personal residence or rental property for tax purposes.
Usually, if the owner occupies the vacation home for more than 14 days per year or at least 10% of the time it is rented out, the property is considered a vacation home by the IRS. If the property owner occupies the house for less than the IRS specified minimums, the property is considered a rental property.
A vacation home is a second residence that is located away from the primary residence, and it is used for recreational purposes such as holidays and vacations.
When a vacation home is not being used, it can be rented out to generate additional revenues for the homeowner.
The IRS requires that the vacation home must be used for 14 days in a year or 10% of the number of days it is rented out for it to be considered a secondary residence for tax purposes.
Vacation Home Explained
Vacation homes are a secondary residence that property owners occupy for a few days or weeks in a year, and they are different from the primary residence. A primary residence refers to the main residence where a homeowner lives for the majority of the year. The primary residence can be an apartment, condo, single-family unit, etc. where the homeowner – either a single individual, couple, or a family – spend the majority of their time.
Vacation homes, on the other hand, are considered a second home that the homeowner uses for recreational purposes such as vacations or holidays for a short duration during the year. The vacation home can be a condominium or a cottage, and the owner can rent it out to generate income when it is not being used. The property should offer basic living facilities such as sleeping space, a bathroom, and a cooking area.
When taking a mortgage loan to buy or build a vacation home, lenders require the secondary residence to be at least 50 miles away from the main residence. If the secondary property is located close to the primary residence, it can be an indicator that the owner intends to rent out the property rather than use it as a personal residence.
Generally, mortgage loans on vacation homes attract a higher-interest loan than a mortgage loan for a primary residence due to the high risk of default. It is because homeowners are more likely to save the primary residence over the vacation home when the property is facing auction.
The IRS requires that vacation homes must be used for 14 days and 10% of the number of days when the property is rented out. For the second home to be considered a rental property, it must be rented at the fair market value rather than a nominal fee that would be charged to family members and friends.
If the IRS requirement is met, the homeowner gets a tax break, and any income earned from the property is tax-free. Therefore, the homeowner cannot deduct any expenses incurred in renting the property when filing their income tax returns. The homeowner is allowed to claim certain deductions, such as mortgage interests, real estate taxes, and casualty losses.
If the vacation home is rented out for a period exceeding the 14-day limit or 10% of the number of days when the property is rented out, the owner is required to report the rental income to the IRS using Schedule E. The owner can also deduct any expenses incurred in generating rental income in the property.
When the property owner sells the vacation home, he/she is required to report the capital gains to the IRS. The federal tax agency charges a tax on the profits generated from the sale of the property. The capital gain is reported on Schedule D in the year when the property was sold, and it should be included in the owner’s annual tax return.
Vacation Home vs. Investment Property
A vacation home and an investment property are used for different reasons. A vacation home is used as the owner’s second residence, and the owner can decide to rent it out to generate additional revenues when it is not being used. When a vacation home is used to generate rental income, it is considered an investment property.
An investment property is used to generate income by renting it or profiting from appreciation when it is eventually sold. Investment properties are not purchased or built as a personal residence, and they are solely used to make a profit. They can be commercial, residential, or mixed-use properties.
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