Want a Vacation Home? Three Ways the Math Can Work

Three women jump into a pool at a vacation home. — (Image credit: Getty Images)

The weather is warming up. Your retired friends are coming back from Florida. Not only did they avoid the cold, but they also got a tax break. Right? In the context of this article, it’s important to differentiate between state income taxes and the tax considerations of owning a vacation property. This article is all about the latter. A future column will address the former.

Before we get into the meat of it, I’ll break the bad news: It is almost never a good financial move to buy a second home. With the advent of Vrbo, Airbnb and similar services, it’s almost always cheaper to rent than it is to buy. Remember, for purposes of this article, we are not factoring in state income taxes that could be saved if you buy a second home and meet residency requirements in a tax-friendly state. That said, below are three ways you can make the math more favorable.

1. Rent out your vacation home for two weeks or less.

By definition, a vacation home is not a rental or investment property. Rentals are reported on Schedule E and have completely different rules than a vacation home. However, the IRS allows you to rent your home for 14 days or less without having to report that income. This can be especially impactful for homes in popular tourist destinations and has been coined the “Masters exemption” because of how much tax-free income is earned by those with homes in Augusta, Ga., during Masters week. Think beach towns during Memorial Day and Labor Day. Think college campuses during homecoming and graduation weekend.

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2. Take advantage of the mortgage interest deduction.

Yes, you can deduct mortgage interest on a second home. However, there are a few things to be aware of. This benefits you only if you itemize deductions. On your form 1040, Schedule A reports itemized deductions. You add up all your deductions, and if that number is higher than the standard deduction, you itemize. The standard deduction was doubled as part of the Tax Cuts and Jobs Act (TCJA), and many of the deductions were capped. According to the Tax Foundation, only about one in 10 taxpayers itemizes. To see a benefit from your vacation property, you must be in that 10%.

The TCJA also reduced the amount of mortgage debt that you can use in this calculation. You cannot write off interest on aggregate balances of more than $750,000. Therefore, if you already have a $500,000 mortgage, only $250,000 of debt on a second mortgage property will give you a tax break.

3. Take advantage of the property tax deduction.

Property tax deductions can also be found on Schedule A. This is very similar to the rule above because you must itemize deductions to see any benefit. Also similar is that there is a cap on the deduction because of the TCJA. This is the dreaded “SALT cap.” You are allowed to deduct a maximum of $10,000 in state income taxes and property taxes paid. Most of our clients hit that cap without a second home. In lower-cost areas, you may see a marginal tax savings by writing off a bigger property tax bill.

As I often preach, use your financial plan as a guide to ensure that you can afford a second home. If you want to double-check your plan, you can use this free software.

Once you’ve received the green light from the plan, consider the qualitative factors. What does upkeep look like? How much time will you be able to spend there? You don’t ever want trips to your vacation home to feel like an obligation. If you decide to go for it, give me a shout — I’d love to visit!

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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After graduating from the University of Delaware and Georgetown University, I pursued a career in financial planning. At age 26, I earned my CERTIFIED FINANCIAL PLANNER™ certification. I also hold the IRS Enrolled Agent license, which allows for a unique approach to planning that can be beneficial to retirees and those selling their businesses, who are eager to minimize lifetime taxes and maximize income.