Once you decide to buy that vacation cabin, you’re committed. If you vacation anywhere else, you feel like you’re squandering your investment. Yet you can’t spend all of your time there, and it would sure be nice if you could get some tenants while you’re not there. It’s even nicer if the IRS can help you pay for it.
Flickr image courtesy Let Ideas Compete under Creative Commons license
And yes, there are tax breaks for second homes. The biggest one is the home mortgage interest deduction, available for up to two homes. You can also deduct property taxes, at least if you aren’t subject to alternative minimum taxes. But what about the home itself, and your out-of-pocket costs? Can you claim the cabin as a rental property, deduct depreciation, insurance, and maintenance, and move your property taxes to an “above-the-line” schedule E deduction?
Probably not. It didn’t work for a California man with a 3-bedroom cabin. The man deducted $20,258 as Schedule E losses in 2004. The Tax Court sets the stage:
Petitioner contracted with Alpine Resort Rentals (Alpine), a property management company, to rent the cabin for the 2004 tax year. Per the rental agreement, Alpine had an exclusive right to rent the cabin during 2004. For its services, petitioner paid Alpine a 35 percent commission of all rental income received. Among other things, Alpine was responsible for arranging housekeeping and linens for rental customers; petitioner was responsible for maintaining the property in a safe and aesthetic condition, paying all utilities, having the property “deep cleaned” twice a year, and providing linens.
The cabin was rented 3 times during the 2004 tax year, for a total rental period of 12 days and 9 nights. The parties have agreed that the average rental period of customer use for the cabin for 2004 tax year was 3 days.
Petitioner visited the cabin eight times during 2004, for a total of approximately 27 days and 19 nights. Each time petitioner visited the cabin during 2004, he was accompanied by family members.
The IRS attacked the loss on two fronts. First it went after the loss under the “passive loss” rules. Normal rental real estate losses are subject to a “per-se” passive loss limit, unless you are a real estate professional. Our Californian tried to take advantage of a special rule that allows taxpayers with adjusted gross income under $150,000 to deduct rental real estate losses when they “actively participate” in the rental activity. The IRS countered:
An activity involving the use of tangible property, however, is not considered a rental activity for a taxable year if for such taxable year the average period of customer use for such property is 7 days or less. Sec. 1.469-1T(e)(3)(i) and (ii)(A), Temporary Income Tax Regs., supra. Therefore, owners of rental real estate are not considered to be engaged in a rental activity if the average period of customer use is 7 days or less.
Failing that, the taxpayer argued that if it wasn’t a “per-se” passive activity, he wasn’t “passive” and could deduct the losses under one of two rules: either he did “substatially all” of the work involved in the property, or he spent at least 100 hours and more than anyone else. The Tax Court said this failed too (my emphasis):
To satisfy one of these tests, petitioner must establish that either (1) no other individual’s participation exceeded petitioner’s participation during 2004 or (2) that petitioner participated in the activity for more than 100 hours in 2004. With regard to the second requirement, petitioner has set forth little evidence to establish that he was involved in the rental of the cabin for more than 100 hours in the 2004 tax year. He has alleged that he took eight maintenance trips to the cabin during 2004, but in no way has he quantified for the Court the amount of his active participation time. In order to establish that he did spend more than 100 hours engaged in the rental of the cabin, the Court would expect petitioner to provide evidence corroborating his claim that his trips to the cabin were indeed for the purpose of maintenance, e.g., in the form of time logs, oral testimony, and/or receipts.
Nor has petitioner established that no other individual’s participation exceeded his participation in the activity or that his participation constituted substantially all the participation in the activity. Alpine was responsible for advertising, showing, and renting the property, and after each tenant, a cleaning service cleaned the property. Further, petitioner has conceded that his daughter assisted in the management and maintenance of the cabin and that he contracted with professionals to provide repair services during 2004. While we do not know how much time these services took, they involve a substantial amount of time.
It’s up to you to prove your participation, and the Court found the taxpayer failed to do so.
The other IRS line of attack on vacation home deductions is Sec. 280A, which limits operating deductions for vacation homes to rental income if the cabin is used personally for the greater of 14 days or 10 percent of the day is is rented. Maintenance trips don’t count as personal use, but again it is up to the taxpayer to prove that a trip is a maintenance trip:
Petitioner has presented no evidence to substantiate his contention. He has not provided to the Court any receipts, work reports, time logs, or testimony to support his claim that the motive of his trips and his activity at the cabin was in fact for upkeep. Although cautioned at trial that his opening statement was not evidence that the Court could rely on to make findings of fact, petitioner chose not to testify at the trial, relying entirely on the stipulation of facts and the stipulated exhibits to provide all of the evidence in his case. Hence, petitioner has failed to meet his burden of proving that personal use of the cabin did not exceed the greater of 14 days. Consequently, the cabin is considered a residence for purposes of section 280A.
The taxpayer didn’t lose all of his tax breaks. Because he rented the house for less than 15 days in 2004, he was allowed to exclude the rent received from taxable income. He also was allowed itemized deductions for his mortgage interest and property taxes. But the rest of the deductions — depreciation, repairs and so on — were lost.
The Moral? If you want to take deductions for your vacation home above the line, you need to keep records of how much time you spend there, and how you spend it. If you can’t prove your participation, the tax law won’t help you.
Cite: Akers, T.C. Memo 2010-85
Related: NON-PASSIVE RENTAL LOSSES: NO FUN WITH DICK AND JANE
Joe Kristan writes the Tax Update items, and any opinions expressed or implied are not necessarily shared by anyone else at Roth & Company, P.C. Address questions or comments on Tax Updates to
