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Summertime Home and Travel Tax Breaks

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Summertime is the prime time for many people to enjoy vacation homes and travel. And vacation time is even more enjoyable if you can finance it with tax-free income and take tax deductions for your expenses. Opportunities…

Home and Vacation Home

  • Tax-free income from your home or vacation home. If you rent out your home and/or a second home that you own (such as a vacation home) to others for fewer than 15 days during the year, the rental income you receive is totally tax free — you don’t even have to report it on your tax return. This is one of the simplest and best tax breaks in the Tax Code.
  • Vacation planning: If a special event (sports competition, concert, etc.) draws tourists to the area where you live, or there is a “high season” during which rentals are highest where your vacation home is located, rent your home/vacation home out at that time for up to two weeks. Use the tax-free income you receive to finance your own vacation.

  • Mortgage deduction for buying a boat, recreational vehicle (RV), or vacation home. You can deduct interest on a total of up to $1 million of mortgage borrowing used to acquire your primary personal residence and a second residence.
  • Opportunity: The second residence may be a boat or RV, not just a conventional vacation home. To qualify as a residence, a boat or RV must have “living accommodations,” including a sleeping space and kitchen and bathroom facilities, and you must use it more than 14 days a year. Property taxes, if any, are deductible on your second residence, including a boat or an RV, too.

  • Vacation home tax shelter. If you rent out your vacation home for more than 14 days during the year, all of the income that you receive is taxable, but you also become entitled to deduct expenses related to your rental activity.
  • Examples: Depreciation, maintenance costs, utilities, insurance, advertising.

    To get full deductions, you must limit your own use of the home to no more than the greater of 14 days or 10% of the number of days it is rented to others. If your deductions exceed the rental income you receive, up to $25,000 of this excess can be deducted against your income from other sources, such as salary. (This loss deduction phases out as adjusted gross income increases from $100,000 to $150,000.)

    This tax loss deduction can turn your vacation home into a legal tax shelter. You can claim it even as the home appreciates in value and even if it provides you with positive cash flow. (Depreciation is a deduction with no cash cost, so it can result in a tax loss even if rent is giving you net cash income.)

    Deduction rules can be complex, so check them in IRS Publication 527, Residential Rental Property.

  • Tax-free gain “bonus.” If you buy a vacation home in a popular area that increases in value over the years, you may be able to sell it in the future for the same tax-free gain of up to $250,000 ($500,000 on a joint return) that is available on primary residences.
  • How: Move into it and use it as your primary residence for at least two of the five years before you sell it. If you sell your original primary residence, move into your vacation home and then sell that, this can give you two such tax-free gains in a period of just over two years (the minimum time allowed between tax-free home sales).

    In this way, a vacation home subsidized by the IRS with all the tax breaks mentioned above may add to your tax-favored retirement wealth as well.

    Travel Tactics

    Combining business with pleasure can give generous business expense deductions for a business trip that has a substantial pleasure element — even if you bring a personal companion.

    Basic rule: If the primary reason for a trip made within the US is for business, you can deduct the full cost of travel to and from your destination and also hotel costs at your destination, even if the trip contains a significant pleasure element.

    You can even have days on which you do no business if they are between business days, such as a weekend between a Friday and Monday on which you do business, or a holiday weekday, such as July 4 or Labor Day.

    Note: You can’t deduct the extra cost of nonbusiness side trips or purely recreational expenses (such as sports event tickets). If you extend your stay for personal reasons, you can’t deduct hotel costs incurred for the extra days.

  • Foreign travel. Different rules apply when you travel outside the US. You can deduct the full cost of travel to and from your destination if travel is viewed as entirely for business. Some ways to qualify: Travel lasts no more than seven days… travel is more than a week but you spend no more than 25% of the time on nonbusiness activities.

    Business days are those on which you actually perform business. They include days spent traveling to and from your destination, provided the day after you arrive and the day before you leave are business days. Therefore, plan vacation days in the middle of a trip rather than next to travel days.

    If you fail both of these tests, then your deduction for travel expense is limited to the proportion of travel expenses that matches the percentage of trip days that were business days, plus actual business day expenses.

    Example: You spend 30 days in Paris, 20 of which are business days. You can deduct two-thirds of the cost of traveling there and back, along with the expenses of the 20 business days.

  • Companion’s expenses. If you travel with a companion, you can still deduct the full cost you would have incurred if you had traveled alone — and the extra cost of bringing a spouse along may be slight.
  • Examples: You can deduct the full cost of a single hotel room, even if a double room costs only a little more… the full cost of a rental car you would incur traveling alone, even if having a companion adds no cost… the full cost of a single airfare, even if the cost of two tickets is little more than one due to a family fare discount.

    You can also sometimes claim business meal and entertainment deductions for a spouse (or other personal companion) who travels with you.

    Example: Your spouse accompanies you on a business trip and to a business meal and entertainment (M&E) activity (such as a theater performance after the meal) that you attend with a business associate and the associate’s spouse. Since the associate’s spouse is there, your spouse can be considered to be there on a business basis (to help entertain). Even if the associate does not bring a companion, your spouse’s attendance for business purposes — perhaps he/she is a native of the associate’s country — might still be allowed. The cost for all four people is deductible under normal M&E rules (with 50% of the cost deductible).

    Net result: If you travel with a com­panion, you may be able to deduct much more than half your total trip cost.

  • Conventions. If your trip is not to a business meeting but to a business convention held within the “North American area,” normal business travel deduction rules apply. This is true even if the convention or seminar is held at a location noted for its entertainment, such as Las Vegas.
  • The North American area includes Canada, Mexico, several Caribbean nations, and certain Pacific Island locations.

    Requirement: The business convention or seminar must specifically relate to your business or profession.

    If you attend a business convention held outside the North American area, no deduction is allowed unless you show that it is “reasonable for the convention to be held outside North America” — you must show a justification for its location.

    You cannot deduct trips for personal investment purposes (such as conventions, seminars, or shareholder meetings). For detailed rules about deducting business travel, and exceptions that apply in special circumstances, see IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses.

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    Source:
    Source: Laurence I. Foster, CPA/PFS, tax consultant based in New York City and former partner at Eisner LLP. Mr. Foster was chairman of the Personal Financial Specialist Credential Committee of the American Institute of Certified Public Accountants.
    Date: July 1, 2008 Publication: Bottom Line Personal
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