The IRS has announced they will issue regulations that would prohibit taxpayers from claiming a charitable contribution deduction for amounts for which the taxpayer claimed a state tax credit. Governor Jerry Brown (California) vetoed SB 539, which the Legislature had hoped would allow taxpayers to claim a charitable contribution deduction for donations to the College Access Tax Credit Fund. And the states of New York, Connecticut, Maryland, and New Jersey have sued the U.S. government in federal court seeking to invalidate the $10,000 limitation on state and local taxes. The battle continues, but in the meantime, taxpayers with a second or vacation home should begin planning to implement a workaround strategy to the deduction limitation.
One strategy to consider is the allocation of mixed-use expenses for vacation homes. Vacation homes are properties used by the taxpayer for some days of the year and rented to third-parties for other days of the year. A vacation home is not a rental property which is rented (or held out for rent) for 365 days of the year. A vacation home is not a personal residence which is the home you live in, and it is not a second home that you own which is not rented at all (such as a vacant home or house you use periodically throughout the year with no rental days).
The IRS and courts are in disagreement with the expense allocation method. The IRS method was not taxpayer-friendly under the old law, but it is favorable to taxpayers under the new law because their method allocates more of the property taxes to rental use; thereby, increasing the property tax deduction carryforward. Your property taxes allocated to rental use can be carried forward indefinitely to offset future rental income which is more favorable because you cannot carry forward property taxes reported as Schedule A Itemized Deductions. The limited tax deduction is lost forever. You may have used the court method in the past, but with proper tax planning, you may want to switch to the IRS method. The following link is to an example that illustrates the tax benefit of using the IRS method. And remember state law may be different.
IRS and Court Method Example
Line 8 shows the larger tax deduction carryforward using the IRS method. So the future tax savings, assuming a 40 percent tax rate, is about $9,000.
A second strategy is to rent your second home. If you rent your home for less than 15 days, the rental income is not taxable. If you rent the house for more than 15 days, you may be able to offset your rental income by the allocated expenses (including the previously disallowed property tax deductions). You need to run tax projections to confirm the amount of taxable income generated by this strategy.
Call us at (323) 285-9880 if you have any questions about the allocation of mixed-use expenses for vacation homes. We have the knowledge and skill to calculate complicated income tax projections. Call us at (323) 285-9880.
Disclaimer: Tax laws are complicated, and your taxes are unique to you. A law favorable to you may not be beneficial to the next person because the facts and circumstances are different. Our emails are very broad and do not provide specific tax advice to you for which you can use for tax planning purposes. Therefore, we highly recommend you contact us before taking any action concerning the content of this email.