GMAC Real Estate Second Home Tax Deduction and Depreciation
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Second Home Tax Deduction and Depreciation

Takeaways

  • Use tax benefits to improve the cash flow of investment second homes.
  • Depreciation of your property is a great way to show a paper "loss" for tax purposes.
  • Avoid the automatic depreciation recapture tax with a 1031 exchange.

Did you know?

  • Mixed-use second homes can switch between personal use and investment real estate each tax year if you choose.
Tax benefits can improve second home cash flow. Cash flow is the lifeblood of any business, and once you own rental property a great way to maximize cash flow is through tax benefits. The key to realizing these benefits is to be a materially participating investor. You also must own at least a 10% interest in the real estate to fully maximize these benefits, a figure that eliminates most participants in large partnerships or group investments, such as real estate investment trusts (REITs).

Be Involved

A materially involved investor makes major decisions such as creating and overseeing policies for tenant selection and repair. This is an easy-to-meet threshold for the "hands-on" property owner, but investors who hire property managers to oversee the day-to-day operations can still pass this test by staying actively involved in the big picture. Vacation-home owners with property in a rental pool with outside management typically do not meet the required criteria.

The rental real estate owner who passes both tests is allowed a deduction of investment property losses against taxable income. The investor with an adjusted gross income of less than $100,000 can deduct up to $25,000. The amount incrementally declines to zero over $150,000 AGI.

The upside is unused deductions can be suspended and used in a later tax year, and even may apply against capital gains taxes when the property is sold. The IRS even allows suspended tax losses to be used in aggregate instead of by property when selling your second home real estate.

Depreciation is Your Friend

One thing to keep in mind about deductions based on property "losses" is these losses are often only realized on paper, not as an out-of-pocket cash loss. The secret is depreciation. You can claim depreciation on the "wear, tear and obsolescence" of the structure, on personal property, such as a dishwasher used at the rental, and even equipment purchased to operate the investment, including your vehicle.

There is something of a lump of coal involved with depreciation deductions. The IRS imposes a hefty recapture tax of 25% on the total depreciation deducted during ownership. A way to defer this tax is through a 1031 exchange with another property with equal or greater value to the real estate being traded.

For the investor who is jumping into rental second homes with both feet and spends over 50% of all working hours on real estate there are some additional tax breaks. If you qualify as a "real estate professional" there are unlimited deductions related to investment property against your ordinary income.

Search for Second Homes for Sale

To search for a selection of second homes for sale, please visit lifestylehomesearch.com, or visit the website of a GMAC Real Estate Office that serves the area where you'd like to buy a second home. To learn more about buying Second Homes or Vacation Homes, explore the rest of this section, or contact a GMAC Real Estate Agent.