What are my “out” options?

If you decide the property isn’t working out for you, how hard will it be to sell it or rent it out? How much will it cost you? Planning ahead and coming up with a plan B will help you deal with potential surprises.

Often, it’s not where you look for a second home, but who you get to help you. If your mortgage broker has a CMPS at the end of his name or title, that’s a good clue. It means that he’s a certified mortgage planning specialist and has been heavily trained in financing second homes.

Some homeowners are surprised to learn that if they rent the house for just one month, that income is reportable and taxable — even if they have no plans to rent it again in the future. In addition, any deductions you take (such as the property tax or mortgage-interest deductions mentioned above) may be limited to the amount of rental income generated by the property.

If you try to live in two places at once, it might cost you. On rare occasions, people who split time between two residences in different states can be on the hook to pay taxes in both states. Example: Your primary residence is in California, but you also do business in New York and have a second home there. If you are filing a nonresident income-tax return based on those New York business interests, you have to disclose that you also own a home in the state — and if you spend more than 183 days of the year in New York, you’ll be taxed on your “worldwide income,” in both California and New York.

If you’re planning to buy a home this year, you’ll need to do more than just find the right real estate agent and get preapproved for your mortgage loan. One of the key items on your to-do list: understanding how your home purchase will affect your taxes. Thanks to tax reform, the rules for buying a home this year will be very different than if you’d bought your home last year.

See below on how has tax reform has affected homebuyers? Here are six key ways.

1. Home equity loans aren’t deductible anymore

Home equity loans allow homeowners to tap into the value of their homes. While there are risks to borrowing against the equity in your home, this type of loan does provide a way to take cash out of one of your most illiquid assets.

Under tax reform, however, you’ll no longer be able to deduct the interest if you get a home equity loan. While you could previously deduct interest on a loan of up to $100,000, this deduction is gone in 2018.

2. Forget about deducting mortgage interest on a second home

If the home you were planning to buy is a vacation home, tax reform means you’ll pay more for your getaway. While you could previously deduct mortgage interest on a second home as well as on a primary home — as long as your combined mortgages were under the $1 million cap — this is no longer permitted under the new rules.

The ban on deducting interest on a mortgage for a vacation home affects only new purchases, so if you already have a vacation home, you may want to hang onto it.

3. You may not be able to deduct all your mortgage interest if you’re buying a more expensive home

While wealthy homeowners with big mortgages currently get the biggest tax breaks from the home mortgage deduction, things are changing. Under the new rules ushered in by tax reform, the mortgage interest deduction is capped at $750,000 for newly issued mortgages. Previously, homeowners could deduct interest on mortgages up to $1 million.

This change is expected to make it more difficult for higher-priced homes to sell, reducing their value. It will definitely make buying a high-end home cost more.

Homebuyers in expensive markets — especially those in the District of Columbia, Hawaii, and California — are likely to see the biggest impact. In California alone, there are seven counties where the average home price exceeds $750,000.

Since homebuyers typically make a down payment, those with homes valued at up to $937,500 who put down 20% or more will still get to deduct the full amount of interest on their mortgages. Still, many homeowners stuck in places with high housing prices are likely to have at least some nondeductible interest that previously would have provided a tax break.

4. Your state and local taxes may no longer be fully deductible either

If you’re buying a home, one of the costs to factor in is property taxes. While real estate taxes can be expensive, homeowners were previously permitted to deduct the full value of taxes paid to local governments from their federal returns. This is no longer the case.

Tax reform capped the total state and local tax (SALT) deduction that you’re allowed to take at $10,000. If your property taxes combined with other local taxes exceed $10,000, you’ll lose out. This change is also likely to hit wealthy homeowners in high-tax blue states — like New York — very hard. In New York’s Westchester County alone, almost 75% of homeowners pay $10,000 or more in property taxes.

Nationwide, an estimated 4.1 million pay property taxes in excess of $10,000, according to ATTOM Data Solutions. Many of these homeowners also have state income taxes to pay. For the first time since the federal income tax was created in 1913, they’ll be taxed by the federal government on money the states have taken.

5. Capital-gains rules for home sales stayed the same

There is some good news for homeowners. While there were proposals to change the rules for avoiding capital gains taxes on the sale of a home, these changes didn’t make it into the final bill. Taxpayers continue to be eligible to exclude $250,000 in gains for single filers, and $500,000 in gains for joint filers, if they sell their home at a profit. You can avoid paying capital gains on your home sale as long as you’ve lived in the house for at least two of the five years prior to selling.

Since you can’t invent a time machine, the best thing to do is just run the numbers, make sure you don’t end up with a house that stretches your budget too thin, and look for other ways to save on taxes where you can.

Return to the post of “Vacation Home and Taxes“.

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