Buying, owning vacation home involves lots of tax concerns

Tax rules are complicated for those who own second or vacation homes. A key factor involves whether the property is rented to short-term tenants - and how often.

Q. We were fortunate to have weathered all the financial turmoil last year pretty well, and now we would like to use some of our money to buy a vacation home, because there are some really great bargains out there. We probably would rent it out sometimes when we are not using it in order to help cover our expenses. What are the tax rules regarding income from vacation properties?

A. The tax rules regarding the treatment of vacation rentals depend largely on how often you use the property yourself and how often you rent it out.

If you rent the home out for 14 days or fewer each year, you usually do not have to report any of the income. Instead, the property will be considered a personal residence, and you can take the usual write-offs for mortgage interest payments, property-tax bills and all the other deductions you take for your primary home.

Should you rent out the home for more than 14 days each year, the Internal Revenue Service likely will consider your second home a "rental property," and you will need to declare all of your rental income on your tax return. On the upside, it also will allow you to deduct some or all of your rental expenses, such as the cost of finding tenants or the expense of hiring a maid service to clean up after them when they leave.

Now, here's where it gets really tricky: If you use the home for more than 14 days or more than 10 percent of the days it is rented - whichever is greater - it is once again considered a personal residence. Should you fit into this category, you can deduct the rental's expenses up to the amount of income that it generates. Losses, however, cannot be written off.

Finally, if you use the property yourself for 14 days or fewer each year or less than 10 percent of the time it is rented, the IRS will classify your home as a business. This will allow you to deduct your expenses and, depending on your income, up to $25,000 per year in losses. It's worth noting that if your home is indeed considered a business, the time you spend fixing up or maintaining the property generally doesn't count against your "personal use" days. That's why many second-home owners prefer to schedule their vacation trips so they can do some work on the house while they're there, so they'll have some "extra" days later to just go back and relax without reducing their tax benefits.

Because these tax rules are so complicated, it's important to consult an accountant or similar tax professional for details.

Q. What is an "absolute" auction? Is it any different from a traditional auction?

A. Yes. In a typical auction, the seller usually has the right to pull the property off the sales block if bid prices fall short of expectations. Conversely, in an absolute auction, the owner often is required to sell even if bidding proves disappointing. But even in some absolute auctions, sellers are allowed to set a minimum level where bidding must start, and can yank their property from the block if the opening minimum isn't met.

Q. A year ago, my neighbor complained that the cinder-block wall that separates our property was about three feet over his property line. We shared the expense of a survey and found that the wall indeed stood about 40 inches on his side, so I paid the entire cost (about $3,500) to have the old wall removed and a new one built in its proper location. Because the fence was moved, the trees that were once on my side of the property are now on his - and now he wants me to pay the full cost of their removal! What can I do?

A. You were right to pay for half of the survey a year ago. You were, however, under no legal obligation to pay the entire cost of subsequently tearing down and then rebuilding the fence - especially if it was there when you first moved in and you did not build it yourself. And it's downright incredulous that, after getting nearly three and a half feet of land and a new fence for free, your neighbor now wants you to pay for the cost of removing the trees that were once on your side of the property. If you want to keep "playing nice," I suppose you could offer to pay for half the cost of removing the trees. But frankly, I wouldn't even offer to do that. Instead, I'd tell him that the "free" trees are now on his "free" property, and it's his responsibility to take care of them. Should he remove the trees and then file a small claims court lawsuit to recover his expenses, I would then file a countersuit to recover half the cost of removing and rebuilding the wall that now accurately straddles the property line.

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© 2009, Cowles Syndicate Inc.