A home near the beach, a condo in Spain or a ski house nestled in the mountains. A second home is the American dream.  With the lowest mortgage rates in years, this is a great time to look at second homes.

The second home also offers many advantages, not the least of which is providing a vacation retreat for your family.   Let’s look at some of the tax advantages and tax consequences of the second home as well as the second home that is rented part of the year.   The tax consequences depend upon the amount of time the home is rented and the amount of time you use the home for personal purposes. Under the new rulings, your deductions will be based on whether your second home is classified as “residential" or "rental."
 

1) > If you rent your vacation or second home to paying guests fewer than 14 days per year (regardless of the amount of rent received), that rent need not be reported on your income tax returns.  But you can fully deduct your mortgage interest, property taxes and any certain casualty losses as itemized deductions on Schedule A of your income tax returns.

2) > If you rent for 14 days or more and use the home 14 days or more, or 10 percent of the time it's rented, then your rental expenses are also deductible. Keep track of them, because they're deductible only up to the amount of your total rental income. Of course, your mortgage interest and property taxes are deductible.

3) > If you rent for 15 days or more and your personal use is less than 15 days or 10 percent of the time rented, then your home is considered a rental property. The expenses you incur in excess of your rental income, as well as property taxes and mortgage interest, are deductible.
The rental income and applicable expenses must be reported on Schedule E of your income tax returns.  Mortgage interest, property taxes, insurance premiums, utilities, repairs and depreciation can be subtracted from the rental income received.

Congress carved out an interesting law that aids those with an adjusted gross income of $100,000 or less. Those in this category who actively manage rental property are allowed to deduct up to $25,000 in losses against other income. The $25,000 limit is gradually phased out for those in the $100,000 and up bracket.  By the time it reaches $150,000, the deduction is eliminated.  Keep in mind that any losses not currently deductible may be carried forward and used against passive income.

To qualify, as an active manager is quite simple: You must own at least 10 percent of the property and make decisions on tenants, rents and maintenance.  When you sign a rental contract with a rental company on Hilton Head, that contract is worded in a manner that considers you an “active manager / participant” in the management of your property. 

NOTE: Schedule E is the place to report the rental income received and applicable expenses. The correct order for deducting expenses is mortgage interest, property taxes, uninsured casualty losses, operating expenses and depreciation.  If mortgage interest, property taxes and uninsured casualty losses exceed the rent received, the excess expenses should be deducted as itemized deductions on Schedule A.