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.
Buying a Home for Personal Use or 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 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 where the property is located.
Tax Advantages of Owning a Vacation Rental Property
The IRS states that if you earn income from 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 you pay for managing, preserving, or maintaining the rental property may also make you eligible for deductions.
Laws on 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. Still, the amount paid must be reported annually via IRS Form 1098 and be included on the owner’s tax return.
Maximum Mortgage Interest Deduction
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 also qualify for deductions, certain repair expenses might need to be capitalized, potentially impacting the property’s basis.
Any sales profits will be subject to federal, state, and local capital gains taxes if the vacation property is sold. A vacation property may also be converted into a primary residence in certain situations.
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 domestic ones.
Furthermore, property owners who incur taxes in a 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 where the property is located.
Consulting with financial and legal professionals is the best way to set yourself up for success. 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.
If you have any questions about these topics or others, please contact one of our experts.
At Vrakas CPAs + Advisors, we strive to take financial worry off business owners’ plates so they can concentrate on running their businesses, serving their customers, and staying ahead of their competition.
