A Coronado vacation home is more than an island getaway. Sure, it’s first and foremost an investment in your happiness, but it’s an equally appealing investment from a financial standpoint as well. A vacation home—particularly one in Coronado, where home values continue to rise—comes with various tax benefits. These benefits include:
Just like with your first home, the interest you pay on the mortgage for your second home is deductible when you itemize your return. Realtor.com explains:
“In fact, you can write off as much as 100% of the interest you pay on up to $1 million of debt, which includes total debt taken on to pay for both homes, as well as money spent on improving the properties. (That’s not up to $1 million for each property—just up to $1 million in total.)”
Rental Property Depreciation
When you own a rental property, you depreciate its value each year, both to deduct the costs of improving the property, and to account for wear and tear. The amount you can deduct each year is dependent on the basis (or cost) of the building (not the land). You can depreciate a property using the Modified Accelerated Cost Recovery System (MACRS) over the course of 27.5 years, which the IRS considers to be the life expectancy or “useful life” of a rental property.
While depreciation allows you to reduce your taxes during the time you own a rental property, a 1031 exchange allows you to avoid the tax obligations when selling the property. With a 1031 exchange, you can mitigate capital gains and apply them to your next property purchase so that you do not have to pay taxes on the value you have depreciated over the years. When you reinvest or “exchange” the gains into a similar property, they become tax-deferred. The process for a 1031 exchange is as follows:
· Hire a 1031 exchange accommodator to handle the funds associated with your sale.
· Hire a realtor to advise you on both the purchase of your new property and the 1031 exchange process. Be sure to let them know that you wish to do a 1031 exchange.
· Disclose to potential buyers that you are doing a 1031 exchange. (There will be no cost to them, but you still need to make them aware.)
· Upon closing, the accommodator will hold on to the funds until you find your next property.
· Identify three properties within 45 days of closing.
· Choose one of the three properties and close within the exchange period of 180 days from the closing date of your current property.
· At closing, the accommodator will utilize the funds from the sale of your previous property.
Tax-Free Profit on Sale
An IRS exclusion allows a married couple to take up to $500k in profit from the sale of their primary residence, tax-free. This entails living in the second home for two of the last five years. Investopedia sheds more light on the strategy:
“This primary-home sale exclusion does not apply if you sell your second home: If you sell a house that is not your primary residence, you may have to pay the usual capital gains tax. If you make the second home your primary residence for at least two years before you sell it, however, you may be able to reap some tax benefits, but it's not as easy as it used to be.”
Are you considering purchasing a vacation home in Coronado? Del Coronado Realty can assist you with not only finding your dream vacation home, but also understanding the tax implications of becoming a vacation homeowner. To learn more, call us at 619-437-1888.