Second Residence . . . or Rental Property?
A home and a primary residence have different meanings, benefits, and drawbacks to consumers and tax specialists. For example, do you want the depreciation and maintenance benefits of a rental home or the mortgage-interest deduction of a second residence? A personal residence cannot be depreciated. An individual can have several homes yet only one primary residence. A home refers to where a person is physically living, as long as his or her stay is more than a temporary one. Primary residence involves both physical presence in a place and intention to make that place one’s home. Residence without “the intention to remain indefinitely” generally will not constitute primary residence. An individual’s motive for changing primary residences – even for tax reasons - does not raise red tax flags. However, consumers must show at least some sort of intent to establish a primary residence.
If you are considering making your vacation home your permanent residence, now or in the future, you should begin planning for a change in primary residence. If you have been using your vacation home as a rental, consider converting it to personal use for a period of at least two years. That way, if you have to sell unexpectedly, you can keep up to $500,000 in gains tax-free. However, use caution and keep a paper trail. During the past two decades, more than two million individuals have migrated to popular second areas like the Sunbelt states of Georgia, Florida, Texas, the Carolinas, plus the southwest states of California, Arizona, and New Mexico. Some people who retain homes and remain active in business or community affairs in their original states are finding that state tax officials are challenging their change of personal residence. The states say that these folks are still residents for income or estate tax purposes because they have not abandoned their original personal residences. However, when intent conflicts with facts and circumstances, determining which residence is actually an individual’s primary residence can be confusing. The determination is usually based on the individual’s objective and facts such as:
- Registering to vote
- Having bank accounts and securities accounts
- Payment of local taxes
- Time spent in state of residency
- Continuous car registration and driver’s license
- Furnishing, appointing primary residence more extensively
- Using of state of residence address in registrations and applications
Not as important, yet certainly noteworthy, is the fact that some states impose a tax on the fair market value of intangible personal property owned or controlled by their residents. The intangible personal property that is subject to tax generally includes:
- Stock options
- Commodity futures and contracts
- Notes, bonds and other obligations for payment of money
- Stocks and shares of incorporated or unincorporated companies, business trusts and mutual funds.
States have numerous statutory exemptions from the intangible tax for particular assets such as money and cash equivalents, securities issue by the U.S. government, and interests in partnerships that are not publicly traded.
Tax planners say you can eliminate your intangible tax liability if you structure your planning strategies correctly and implement them on a timely basis. Consider timing your move to avoid the initial year’s tax or by restructuring the ownership of tangible assets. You will also want to consider the state income tax consequences of a change of residence. If you have bonuses coming, stocks options or other deferred compensation (as is the case, for example, with many professional athletes) carefully plan how you receive these funds relative to your move to avoid excessive state income taxes. All of you art collectors will want to know that some states impose a sales tax or use tax on tangible personal property used, stored, or consumed in that state. Tangible personal property usually means personal property that can be seen, weighed, measured, or touched. The tax is imposed not only on retailers but also on consumers of tangible personal property.
According to Rob Keasal, residential tax specialist in the Pacific Northwest accounting firm of Anderson Zurmuehlen & Co., P.C., taxpayers often already own the property and would not have to pay a use tax for stepping across the border and changing residency. “In some states, when a rental is sold with tangible personal property, like
a stove and refrigerator, it is considered incidental to the real property and no sales or use tax is paid when the property changes hands,’’ Keasal said. “ However, many states are getting tougher. I’ve seen at least one state that even has a use tax reminder on its income tax return.’’
Other accountants concur. States have become more aggressive in enforcing their sales and use tax laws. They have gone to great lengths – examining U.S. Customs reports, auditing tax gallery sales, personal checkbooks, and credit card statements and sharing that information with other states. Some states have enacted strict filing responsibilities and record retention statutes with respect to individuals who are subject to sales and use tax laws. Persons who relocate to states that have enacted sales and use tax laws may be liable for use tax on their purchases. For example, if you purchase goods from out-of-state vendors that are shipped into your new home state, you may be responsible for paying use tax on those goods.
In addition, there can be other significant considerations, other than rental income generation and tax savings, for flip-flopping the status of a rental property to a personal residence, and vice versa. Many times, these reasons can be social or legislative. For example, property owners with cabins along the shore of a remote mountain lake held a community meeting to formulate a plan to halt, or drastically curtail, logging companies from taking acres of evergreen trees near their mountain paradise. Some of the folks attending the meeting said their questions and concerns would strike more of an impact on local legislators if they were registered voters of the local county. But most of the people in the room only visited the lake during the summer months, and transferring their voting privileges would mean transferring their principal residence. Clearly, many had come to depend upon summer rental income to ease county tax and cabin repair costs. Others have never rented out their place, and wanted a place to use whenever and however they pleased. The big question for second-home owners becomes: Do you want the depreciation and maintenance benefits of a rental home or the mortgage-interest deduction of a residence? A personal residence may not be depreciated.
A home does not have to actually be used to qualify as a residence. If there is no rental or personal use of a residence for an entire year, it can be designated as a ``qualified residence'' and mortgage interest can be fully deducted.
If it is rented for a majority of the year and used just two weekends by the owner, no interest can be deducted under the personal-residence rule.
The rule is that personal days must exceed the greater of 14 days or 10 percent of rental days. The personal-use requirement must be met before a property can be designated a qualified residence. If the home is rented more than 140 days, there will have to be 15 days of personal use before the interest can be deducted fully under the residence rule.
Since the 1986 Tax Reform Act left mortgage interest on first and second homes intact, accountants and tax advisers have asked clients to weigh renting versus personal use very carefully. The deductibility of rental expenses and mortgage interest enters a gray area when you alter the cut-and-dried, 14-day or 10-percent guideline.
If you have the ability to rent winter and summer, you can also get in more personal-use days under the 10 percent rule. A mountain resort that doubles as a snow and water ski area, for example, might have the potential for 250 rental days a year, allowing the owner to use it for 25 days without forfeiting its rental status.
Another way to pick up a day or two on the slopes without eating into your 14-day or 10-percent limit is to clean the house yourself between renters. Days spent maintaining the house do not count toward your personal use limit. You can even deduct travel costs to get to the house and expenses such as paint and cleaning supplies.
The house also must be rented at fair-market value. If you rent to relatives at discount rates, the Internal Revenue Service may rule that the house is not a business and disallow many of your deductions.
It's a good idea to consider a second home - for rental or personal use - simply because houses will continue to appreciate in many areas of the country for some time. And, if you want that getaway all to yourself but find you can't afford the mortgage payments after you buy it, go ahead and rent it. You can juggle rental and personal use status from year to year.
The tax laws have changed how we look at second homes. The getaway that was once viewed only as a luxury is now not a bad place to stick your savings. And in a few years, you may even be able to retire into what has become the best investment you ever made.
The Lending Difference
The personal residence or rental question also will surface when dealing with a lender. In Report # 103 - “Seven Sensational Solutions to Funding a Second Home” we will offer some creative ways you may not have considered to help you get in the door of a second home. However, the conventional method typically entails making a down payment (from savings or liquidating other assets) or taking out a home equity loan on your primary residence for the “down” on a Temporary, Bubble, or Final Destination. The remaining balance then can be financed over a term similar to the loan on your primary home – 30 years, 15 years or a variety of adjustable-rate mortgage periods. If the home is a second residence, the rates probably will be more favorable than if the home is rental unit, commonly referred to as a “non-owner occupied” dwelling. If you plan to rent out your home, the lender will want to see proof that you're actually going to generate a cash flow that will help pay the monthly mortgage plus taxes and insurance. In many cases, the lender will ask for a cash flow statement for a property showing its rental history. And, don't count on your bank to take all of a home's estimated rental income into consideration. Even for a property with a long rental history, most lenders will only consider 75% to 80% of the total take. If possible, make purchase offers contingent upon your loan being approved – some lenders will not extend funds in condominium developments where there are renters than owner occupants. Also, make sure you know all insurance costs for your new property. The dizzy world of environmental claims has pushed some homeowner’s insurance premiums out of sight.
When do Prime Renter Candidates Actually Rent?
When do snowbirds start making plans to take flight?
It obviously depends upon the season they are trying to avoid and the environment they are seeking to enjoy. And, because the Internet has made most corners of the world more searchable and easier to visit, more and more guests from the southern hemisphere are bringing their backward seasonal calendar to the states.
Retirees, aging baby boomers, and professionals who can work from a home just about anywhere often yearn for more sun about the time two consecutive fall football weekends are deluged with rain. According to older folks in my neighborhood, the getaway feeling began with a wet week in August.
For those who do not own a second home yet prefer to make an annual sojourn to a different climate, it’s always best to plan months in advance to grab a spot near your favorite golf course, beach, or desert pool.
Alfred and Emily Glossbrenner, authors and consultants who self-published “How to Make Your Vacation Property Work for You,’’ suggest potential long-term renters approach owners during their down time to inquire about the best possible rates.
“Everything depends upon the season,’’ Emily said. “There’s really no incentive for an owner to offer a reduction in his or her weekly rate if they know they can get the maximum for an entire month. But if the place has not been booked, owners will begin looking for that reliable monthly income without the headaches of cleaning for a different customer every week. Depending upon the situation, you could expect to get four weeks for the price of three.’’
Some snowbirds return to the same single-family home, condominium, or hotel room every year. There’s no searching online or asking for referrals from friends who have stayed in the area. The owners are happy to block time for certain repeat customers because they have learned by experience that they are folks they can trust. Remember, the owner’s goal is to recruit and retain good renters. When they find those renters, the owner is willing to go the extra mile to keep them.
If you are not a repeat customer, or merely want to check different rates and fees, the “Big Four” vacation rental sites are VRBO (www.vrbo.com ), Great Rentals (www.greatrentals.com), A1Vacations (www.a1vaactions.com) and CyberRentals (www.cyberRentals.com). Each has its own major plusses. For example, CyberRentals will be happy to share all comments about a specific home.
Christine Karpinski, author, teacher, and vacation homeowner, has been a consultant to owners of vacation rental properties for the past five years. Her helpful website, www.HowtoRentbyOwner.com, offers tips for renters as well.
“I love my snowbirds because many of them are so willing to help when little things go wrong,’’ Karpinski said. “If they see something that needs attention, like a leaky faucet, they just do it. And, unlike a family that’s renting for a week at prime time, snowbirds are more flexible on their days of arriving and departing.’’
Karpinski said a few of her clients are on set incomes and simply pay a little each month toward their next rental. That way, they can earmark an exact amount each month and don’t have to come out of pocket, or tap retirement savings, for one lump sum every year. Typically, the owner would require a reservation deposit, then the balance to be paid in one or two payments. (Most owners require full rent plus a deposit paid prior to the rental period. Payment methods will vary also, but most will take personal checks.)
Karpinski reports most property owners are somewhat flexible on their pricing during certain times of the year. Some even advertise discounts.
“However, don't expect the owners to give their places away just because it's not booked,’’ Karpinski said. “Many owners don't rely on off-season revenue and would choose not to rent it rather than risk (damages) a renter that's asking for a price less than your cheapest deep discount motel.
“For example, some of my off-season monthly rates are lower than one week rates during the high season. I don’t really rely on the income but will take a renter that I know or will be open to having some work done while they’re there.’’
What about cyber crime – renting a unit that doesn’t even exist?
“Truthfully, there is no guarantee,’’ Karpinski said. “The best way to avoid this is to do your homework. We suggest asking homeowners for references or a list of past renters. One good indication of the relative trustworthiness of any given owner/rental is how long they've advertised with sites.’’
In the article “A New Ownership Strategy for Second Homes”, we explain the history and explore the possibilities of combining tax-free exclusions with tax-deferred exchanges, netting second homes, and profits difficult to find in other investment opportunities. Second homes – what other investment gives you sand, surf, mountains, memories, and financial profit?
Copyright Inman News. Used with permission.
Back To 1031 |
