Have you ever daydreamed about how nice it would be to own a house in the woods or along the shore? Here are some financial pointers to consider if owning a vacation home is on your bucket list.
Are you buying the home for personal use or as an investment property?
Foreign vacation properties are still subject to U.S. taxation. The U.S. typically applies the same tax rules to real estate transactions abroad as it does to those within its borders.
That said, property owners who pay taxes in the country where the property is located might qualify for a foreign tax credit on their U.S. tax return. Also, United States taxes are calculated in U.S. dollars regardless of the currency used in the country in which the property is located.
Are you aware of the tax advantages of owning a vacation rental property?
The IRS states that if you earn income as a result of renting out a dwelling you own, you may be eligible to deduct specific rental expenses on your tax return. These deductions include the following:
- Mortgage interest
- Property taxes
- Operational costs
- Depreciation
- Repairs
Any other standard expenses that you pay for the purpose of managing, preserving or maintaining the rental property may make you eligible for deductions as well.
What are laws pertaining to personal-use properties?
Owners can rent out personal-use properties for up to 14 days per year without having to report the rental income they earn. Vacation homeowners can also claim a deduction on their mortgage interest, but the amount paid must be reported annually via IRS Form 1098 and be included on the owner’s personal tax return.
What is the maximum mortgage interest deduction available to you?
The maximum allowable mortgage interest deduction is $750,000. This covers both primary and secondary residences. For properties that owners use for personal reasons, the property tax deduction is capped at $10,000.
However, this limitation doesn’t apply to rental properties because they are classified as businesses. Also, please note that the $10,000 property tax deduction limit — which was introduced by the TCJA in 2017 — is set to expire in 2025 unless Congress renews it.
Rental property owners may also deduct depreciation on their tax return. While property repairs may qualify for deductions as well, certain repair expenses might need to be capitalized, which could potentially impact the property’s basis.
If the vacation property is sold, any profits from the sale will be subject to federal, state and local capital gains taxes. In certain situations, a vacation property may also be converted into a primary residence.
Are you aware that vacation properties in foreign countries are still subject to U.S. taxes?
Vacation properties with non-U.S. addresses are still liable for taxation in the United States. In essence, the U.S. applies the same tax treatment to foreign real estate transactions as it does to those occurring domestically.
Furthermore, property owners who incur taxes in the foreign nation may qualify for a foreign tax credit on their U.S. tax returns. Last but not least, as mentioned previously, United States taxes are calculated in U.S. dollars irrespective of the currency in the place where the property is located.
Ultimately, the best way to set yourself up for success is to consult with financial and legal professionals. They can advise you on how the details of your situation may affect your tax situation, and they can guide you regarding how you should proceed.
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