Tax Rules for Second Homes

If you rent your weekend-getaway house to help pay the bills, your tax picture could become a lot more complicated.

The tax breaks showered upon homeowners carry over to second homes, too, but things can get sticky if you rent out your vacation home to help pay the bills.

First, if you use only use the place yourself -- and let friends and family use it for free -- your getaway is a personal property and you can deduct mortgage interest and property taxes just like you do for your main home. (Interest on up to $1.1 million of debt secured by your first and second homes can be deducted.)

Gains from the sale of the home won't be tax-free as they are for your main home (up to $500,000 for couples). Even though the profit is not tax-free, it is considered a long-term gain and taxed at just 15%.

You can rent the place for up to 14 days without endangering its personal-use status. And, you can pocket the income from such limited rental use tax-free.

Break the 14-day barrier, though, and the property becomes a business. All rental income has to be reported to the IRS. You get to deduct expenses, too, and that gets complicated because you need to allocate costs between the time the property is used for personal purposes and the time it is rented. If you and your family use a beach house for 30 days during the year and it's rented for 120 days, 80% of your mortgage interest and property taxes, insurance premiums, utilities and other costs would be rental expenses. The entire amount you pay a property manager would be deductible, too. And you could claim depreciation deductions based on 80% of the value of the house.

You can always deduct expenses up to the level of rental income you report. If costs exceed what you take in, the chance to deduct the loss depends on two things: how much you use the property yourself and how high your income is.

If you use the place more than 14 days, or more than 10% of the number of days it is rented -- whichever is more -- it is considered a personal residence and the loss can't be deducted. If you limit personal use to 14 days or 10%, the vacation home is considered a business and up to $25,000 in losses might be deductible each year. The tax savings from such losses is Uncle Sam's contribution to footing the bills. The right to deduct such a loss disappears, however, as adjusted gross income (AGI) rises between $100,000 and $150,000. Losses you can't deduct because of this rule can be used to shelter capital gains when you ultimately sell the place.

More at Kiplinger's Personal Finance

• Behold, a Tax Loophole
• Roth 401(k): Think Tax-Free
• An Interactive Tax Map of the U.S.