Deducting your summer vacation
July 29, 2019
By Matthew Latham
Taxpayers are always looking for ways to improve their tax position by increasing deductions or credits, and there are tax provisions in place that are at least worth reviewing with your tax advisor to see if you can take advantage of that lengthy summer trip you are planning.
Expenses that are ordinary and necessary for business purposes are permitted under the tax code to be deducted. This gives you an opportunity to plan if you have a client or business meeting out of town. The travel to the meeting and lodging around the meeting may be permitted as a tax deduction, but the waters could get murky if there is a personal trip added with the business trip. For example, say you have a client in Traverse City and you elect to drive up from southern Michigan to take this client out to lunch. You spend the night in town with the intent of meeting another client in Mackinaw City the next day, but after that meeting you head to the family cottage for a nice three-day weekend.
The mileage up to Traverse City and to the meeting in Mackinaw City likely could be taken as business mileage provided you keep records (such as a mileage log) on the length of the trip. In addition, the meals taking clients out could still be partially (50 percent) deductible as meals, and the cost of the hotel for the one night stay could also be wrapped in as a travel deduction. Keep in mind under the Tax Cuts and Jobs Act (TCJA) that was passed in 2017, entertainment related activities cannot be claimed as a deduction—so an item such as golfing with a client would be non-deductible, though the meals during golf could still qualify.
In the above scenario, the mileage from Mackinaw City to the family cottage is a personal expense and non-deductible.
Don’t fret as the family cottage or second home could still qualify for deductions depending on the use of the home. If it is all personal, then you are still permitted to take the mortgage interest on the home provided you aren’t subject to any of the indebtedness limits that are grandfathered in under the old law ($1 million of acquisition for a joint return) or with the new law ($750,000 on a joint return for acquisition debt).
This deduction is placed on Schedule A, which means you would need more than $24,000 of itemized deductions (joint return) to be able to deduct the mortgage interest on your vacation home. This change occurred for the 2018 tax year under the TCJA.
The property taxes are also potentially deductible. As a personal use asset, the taxes on the property would be subject to the $10,000 tax deduction limits on Schedule A, in addition to needing at least $24,000 of total itemized deductions to be able to take this. As you can imagine, it doesn’t take much for a joint return to hit $10,000 of taxes if both spouses are working and you maintain two homes. If your state withholdings and property taxes on your main home total over $10,000 then you will get no benefit of claiming the second home property taxes since the deduction is capped at $10,000. Don’t forget to include those vehicle registration fees in this number as well.
Don’t get completely discouraged, as there still may be hope if you choose to rent out that second home during the year.
Vacation Home as a Rental
If you rent the property for fewer than 15 days during the year, you are not allowed deductions directly attributable to such rental, but that’s because of a bigger benefit: no rental income is includible in gross income. Deductions allowed without regard to whether or not the home is used for business or the production of income (e.g., mortgage interest, property taxes) may still be taken as noted above.
Mixed Use of Vacation Home
If you rent the property for 15 or more days during the tax year and it is used by the taxpayer for personal purposes for the greater of (a) more than 14 days or (b) more than 10 percent of the number of days during the year for which the home is rented, the rental deductions are limited. Under this limitation, the rental expenses, including taxes and interest, can’t exceed the amount of the rental income.
According to the IRS, expenses attributable to the use of the rental unit are limited in the same manner as that prescribed under the “hobby loss” rules (i.e., the total deductions may not exceed the gross rental income and the expenses are further limited to a percentage that represents the total days rented divided by the total days used). However, the Tax Court has rejected this formula (the decision has been affirmed on appeal by both the Ninth and Tenth Circuit Courts of Appeals). It is the Tax Court’s position that mortgage interest and real estate taxes are not subject to the same percentage limitations as are other expenses because they are assessed on an annual basis without regard to the number of days that the property is used. As a result, the formula employed by the Tax Court computes the percentage limitation for interest and taxes by dividing the total days rented by the total days in the year.
Second Home Used Exclusively For Rental Purposes
If you rent the property for 15 or more days during the tax year, and you do not use it personally for the greater of (a) more than 14 days or (b) more than 10 percent of the number of days during the year for which the home is rented, the rental deductions would not be limited, and you would need to include all income and expenses on schedule E, which would remove things like property taxes and mortgage interest off of Schedule A, removing those limitations.
A vacation home is deemed to have been used by the taxpayer for personal purposes if for any part of the day the home is used:
For personal purposes by the taxpayer, any other person who owns an interest in the home or the relatives (spouses, brothers, sisters, ancestors, lineal descendants, and spouses of lineal descendants) of either;
By any individual who uses the home under a reciprocal arrangement, whether or not rent is charged; and
By any other individual who uses the home unless a fair rental is charged.
Rental expenses do include depreciating the building. Keep in mind the day the property gets sold your basis in the property is reduced by any depreciation allowable or allowed. Second homes that are exclusive rental properties will not have a chance to qualify for the exclusion that exists for gains on sale of your principal residence. Second homes in general may not qualify for this exclusion either.
In the end, it is important that you touch base with your tax advisor to discuss any potential tax concerns or issues that you may have on that summer trip you plan to take. While most will likely fall as non-deductible, there are still potential tax savings that should be discussed.
Matthew Latham currently holds the position of senior manager in Maner Costerisan’s tax department. He specializes in working with closely held businesses in minimizing tax liability and maximizing business growth and value. Matthew can be reached at (517) 886-9587 or firstname.lastname@example.org