Understanding Tax Deductions for a Second Home

A common dream of most Americans is a 2nd vacation home.  Whether your dream vacation home is a hide away on a ski slope or a bungalow by the beach there are some deductions for taxes that can make owning a vacation home less demanding.  A vacation home is anything that has sleeping space, a toilet, and a kitchen.  This could make the purchase of nonstandard vacation homes a possibility, for example, a boat with those minimum qualifications could qualify as a home as could a mobile home. 

            Probably one of the biggest expenses in a vacation home would be the interest.  Most Americans think of deducting the interest on their primary home but most don’t realize that rule applies to your vacation home as well, with some caveats.  The first is that the loan must be for the acquisition of a home or home equity indebtedness.  An acquisition loan is a loan to purchase a primary home or vacation home.  Home equity indebtedness would be a traditional home equity loan taken out with your primary home securing the loan allowing you to buy a vacation home.  These requirements are pretty broad, but they do rule out a deduction for interest when using products such as signature loans, credit cards and other means of financing.  The second caveat that can catch a few people is the overall limit to the total loan amount.  Generally, the max amount of the combined loans cannot exceed $1 million.  The third is that if you rent out the second home for more than 14 days you must use the second home for 14 days or 10% of the rental days whichever is more.  Finally, this deduction is allowed only for 2 homes.  If you have a 3rd home, you cannot deduct the interest from that home in the same year as the other 2.  However, you are allowed to switch which home is considered as your second home to take advantage of the interest deduction which is more profitable for you on a year by year basis.

            What if you rent the 2nd home out?  About a quarter of vacation homes are rented to other people throughout the year.  For taxes, the IRS has created what is called the 14-day or 10% rule.  The way you divide time between personal use of your vacation home versus the amount of time you rent it is the key to determine your status in the eyes of the IRS.  If you rent your vacation home for less than 14 days a year you can pocket the income without declaring it to the IRS.  If you use the vacation home more than 14 days or more than 10% of the number of days the home is rented out, whichever is longer, it is considered your vacation or personal residence.  If you use it for less than 14 days or less that 10% of the time it is rented to others it is considered a rental property and you are considered a land lord.  These definitions determine the amount of expenses you can deduct and the income you have to declare.  If you are considered a land lord by the IRS by staying in your vacation home less than 14 days or 10% of the rented time you can operate the vacation home as a traditional rental.  Allowing you to take the usual deductions and depreciation of a rental property against the rental income received.   If your personal use exceeds the 14 day or 10% limit you are allowed to deduct up to the amount of the rental income received.  The IRS uses a broad definition of “personal” use.  This definition includes yourself and immediate family, parents, grandparents and grandchildren.  The IRS considers any day you rent the property for less than fair market value as a personal day, trading your vacation home to stay at another, and donating it for charitable use.  If you sell your vacation home, if you didn’t reside in it as your primary residence for 2 of the prior 5 years you will owe taxes on the gain.  If you have owned the property for 18 months or longer you will be eligible for long term capital gains treatment currently at 15%.  As is true with other real estate investments if you took depreciation on the property you will be subject to depreciation recapture currently at 25%. 

            There are two more considerations when owning a vacation home.  The first is that if you operate your property at a loss you can deduct up to $25,000 against your earned income.  Once your AGI exceeds $100,000 you are phased out of the ability to deduct the $25,000 against your earned income ultimately becoming ineligible at an AGI of $150,000.  This loss does not disappear however.  You can carry the loss forward to years where you are eligible to use it and if you sell your vacation property you can ultimately reduce your cost basis in the home by the amount of loss that has not been allowed.  Finally, you must actively manage the property.  The IRS generally considers a broad definition of what is active management.  So generally as long as you are making key decisions on the property such as approving tenants, rental terms, repairs and improvements you would be considered as being active.

            The tax advantages of a second home can make owning a vacation home less financially onerous.  Ultimately, while finances play a role in the decision, the only factor is not financial and is often more of a lifestyle choice. 

College and Taxes

The first time filing taxes as a college freshman can cause a lot of questions for the student and the parents and those questions can become very expensive if answered wrong causing you to file your taxes improperly.  Here are 5 common questions of 1st year college freshman.

  Attending a college outside your home state?  Where do you file state taxes?  The federal return is easy.  It needs to be filed with the IRS based on your permanent address.  State returns are a different animal.  Generally, a student files state returns with their home state.  If the student works in the same state as the college, and that state has income taxes which are taken out of the students pay then it is necessary to file what is generally known as a “Non Resident” state return in that state to receive a refund of the taxes taken out of the students pay.

  For students lucky enough to have been awarded scholarships.  Do you pay taxes on those scholarships?  Generally, you do not pay taxes on those scholarships if they are used to cover the cost of tuition and required fees.  Scholarship money in excess of required fees which is used for room and board, travel, research and equipment is taxable.  This amount should be included with wages even if the additional funds are not accounted for in a W2 form. 

  For those paying for college are there any credits or deductions available to you to reduce the cost of attending college?  There are two main credits.  The first is the American Opportunity Tax Credit.  This credit is good for the first 4 years of a student’s post-secondary education.  Post-secondary is a fancy way of saying after high school. This credit allows up to a $2,500 credit for filers with an adjusted gross income of less than $80,000 if filing singly or $160,000 filing jointly.  The second credit is the life time learning credit.  The credit 20% of the first $10,000 of college expenses up to $2,000.  It is used after the American Opportunity tax credit is used up.  You cannot take both credits in the same year for the same student.  Generally, you must have a modified adjusted gross income of less than $65,000 if filing single or $130,000 filing jointly. 

  Now that I know all about the taxes, when is my tax return due?  This one is easy.  Your tax return is due on the 15th of April.  If you are running short on time you can file for an extension.  The IRS provides an immediate 6-month extension.  Filing this extension is easy and can be done online. 

Finally, how do you file your taxes?  It is best not to use one of the big box, tax firms.  They pop-up every tax season in grocery stores, strip malls and temporary offices.  They charge a small fee to file and will try to “sell” you a product to get your return faster.  The IRS provides free tax filing that is available to most tax payers via the IRS website.  This method of filing is free and is generally more correct than the returns filed by the big box tax firms.  If you no longer qualify for free tax filing with the IRS or your tax situation begins to get complicated.  It is recommended that you employ a tax professional such as a CPA or Enrolled Agent.  Both have education and training in preparing taxes and will ensure your return is correct and filed timely. 

Assessing the Needs of an Aging Parent

Planning for the future needs of an aging parent can often be a sensitive and delicate task for adult children to undertake. Baby boomers who must balance the needs of their own children with concerns about their parent’s well-being have become known as members of the “sandwich generation,” as they struggle to provide multigenerational care and support. The amount of stress that comes with stretching oneself too thin is supported by today’s culture, which seems to revere the notion of “superman” and “superwoman.” Luckily, providing care for an aging parent or another loved one does not have to be a task that you face alone.

Although the topic may be difficult to broach, many are surprised to discover that talking with parents about their needs often opens doors of communication and strengthens familial bonds. One way to do this is through an assessment that takes a thorough look at the physical, mental, environmental, social, and financial situation of your loved one. A thorough assessment can reveal areas of concern and prompt you to develop strategies that help ensure that risks are lessened and independence is maintained for as long as possible. You can perform an assessment by yourself or enlist the aid of a professional who can help provide solutions for any situation that might arise.

Consider the following questions and their relevance to your aging parent’s needs:


  1. Does your parent suffer from any chronic diseases or illnesses?

  2. Does your parent experience incontinence, weight fluctuations, bone fractures, unsteadiness, dental problems, or other irregularities?

  3. Can you provide a list of doctors and other medical professionals your parent visits?


  1. Do you have a list of your parent’s medications and dosage amounts?

  2. Does your parent take medicines as directed?


  1. Has your parent ever been diagnosed with any of the following conditions: depression, anxiety, Alzheimer’s disease, or dementia?

  2. Does your parent show signs of mood swings, forgetfulness, confusion, or depression?

  3. Does your parent appear to have a decreased interest in things that once captivated him or her, such as friendships or recreational activities?


  1. With what level of ease does your parent move about the house? Does he or she need walkers, canes, or other special devices, such as bathroom grab bars?

  2. How many of the following activities can your parent perform independently: bathing, dressing, communicating by telephone, walking, climbing stairs, cooking, cleaning, and driving?

  3. If your parent has pets, is he or she able to give them the level of care they require?

Safety Issues

  1. Is the neighborhood secure, and does the home contain safety features such as smoke alarms, grab bars, and non-slip flooring?

  2. Can your parent perform the necessary maintenance on the home and yard?

  3. Does your parent know how to protect him- or herself from predatory scams and fraud?


  1. Is the contact information of friends and family members easily accessible?

  2. Does your parent interact with friends or have social contact on a regular basis?

  3. Is your parent close to family members whom he or she sees often?


  1. Has your parent’s level of personal hygiene remained the same? Does he or she need help with routine tasks such as washing, shaving, or hair and teeth brushing?

  2. Are clothes appropriate and clean?


  1. Is your parent able to pay the bills and maintain good financial health?

  2. Does your parent have, and can he or she locate, legal documents such as wills, powers of attorney, etc.?

  3. Do you know where to find important information about insurance and financial accounts?

You may wish to expand upon this partial list or speak with a professional about areas of particular concern. In many cases, an individual may require more assistance in one area than another.

Boomers who are struggling to meet the demands of older and younger generations may find that outside help is necessary. Proper planning can help smooth the necessary transitions, both financially and emotionally. For many families, long-term care insurance can provide a measure of support. Policies provide a benefit that can be used to pay expenses for varying levels of care, helping to ensure that both medical and financial needs are met. Preparing today can help you provide for your family’s needs tomorrow.

A Realistic Approach to Long-Term Care

When it comes to long-term planning, the realist has an edge. No one wants to think about the prospect of his or her own failing health, but considering it now, in the short run, may make your future more comfortable and secure. One of the most important realities to face is that as people’s longevity has increased over the latter half of the last century, so has the need for long-term care (LTC). While the services available for assistance, such as nursing homes, assisted living facilities (ALFs), adult daycare centers, and in-home care options, have expanded and improved to keep pace with the “graying of America,” public programs and private health insurers have not necessarily adjusted to make long-term care a funding consideration.

The Real Need for Long-Term Care

Long-term care refers to the broad range of services that assists those with chronic conditions in performing the essential activities of daily living (ADLs), such as getting around the house, dressing, bathing, or eating, or the instrumental activities of daily living (IADLs), such as traveling outside the home, preparing meals, or taking medication. A person is generally considered to be in need of long-term care if he or she has difficulty performing two or more ADLs or IADLs, because of physical limitations, cognitive impairments, or both.

Already, increased longevity has spurred a “Sandwich Generation”—people who have the dual responsibilities of caring for aging relatives, as well as children. With public programs and private health insurers providing only limited coverage for long-term care, the burden of costs and services often falls on younger generations.

Funding Realities

No public program—neither Medicare nor Medicaid—is specifically designed to fund long-term care. While many people mistakenly assume Medicare will cover the costs, it actually only covers short-term care. Medigap—private health insurance intended to supplement Medicare—also generally does not pay for costs associated with long-term care. As a result, Medicaid has become, by default, the primary funding source, but an individual must be in a position of financial need to receive assistance.

A Real Alternative

An increasingly popular insurance alternative has emerged to alleviate the strain long-term care may place on your savings and younger generations—long-term care insurance. Long-term care insurance can help pay for long-term care expenses before you or a loved one become eligible for Medicaid, and it may allow you to keep significantly more of your savings. A policy tailored for your needs may assume the costs of a nursing home, an assisted living facility, adult day care, and/or care in the home. In addition, participation in certain policies makes you eligible for tax deductions. Thinking about it in the short run may save you in the long run.

Securing long-term care insurance is a realistic approach that may enable you to maintain your quality of life, while offering you, or a loved one, financial independence and increased options for care.

Nonqualified Deferred Compensation Plans

If your business has certain executives who are vital to its success, providing them with a nonqualified deferred compensation (NQDC) plan could be a winning strategy to keep them with your company. Such a plan represents an agreement whereby one person (or legal entity) promises to compensate another for services to be rendered currently, with actual payment for those services delayed until sometime in the future. As an employer, you are offering an employee extra income that will not be taxed until some future date, usually upon retirement or death, disability, or termination of employment.

From a business standpoint, creating the funding mechanism to help ensure NQDC benefits are there when the employee is entitled to them is the foundation of any plan. From a tax standpoint, making sure that the employee’s benefits are taxed when received, and not before, is equally critical. It is particularly important to get professional advice on the Internal Revenue Service’s “constructive receipt doctrine,” as well as other tax issues related to NQDC plans.

It’s likely that your company already offers a qualified retirement plan, such as a 401(k), which provides the employer with tax deductions for contributions up to a certain limit made to a participant’s retirement account. While these contributions certainly help employees reduce their taxable incomes and defer taxes on earnings from contributions, qualified plans do not pack the financial wallop highly paid executives are seeking. This is because qualified plans usually limit the compensation base used to determine the maximum annual contribution. With no limit on the compensation base, deferred compensation plans can transform a standard benefits package into a financially appealing savings vehicle for selected employees.

A Tender Tether

Explicit in the deferred compensation plan is a contractual promise to provide future payment for ongoing services. Tethering an employee to the company through a vesting agreement is often included in a plan, although many plans offer immediate vesting, which is to the employee’s advantage.

For example, an employer may stipulate that the employee stay with the company for a certain number of years before the employee is entitled to the compensation. Such an agreement encourages loyalty and commitment on the part of the employee. Prohibiting employment with a competitor (a noncompete agreement) can be another condition of the agreement.

What’s in the Pipeline?

The agreement you make with an employee will specify the type of benefits and how and when they will be made available. Salary continuation—say, providing $10,000 per month for life beginning at retirement—and annual contributions to an investment account where the balance is then paid at retirement—are typical benefit formulas of NQDCs. Whether the money is actually set aside into an account, or merely exists on your books, is up to you. Employers who offer these plans, however, must be confident that the future profitability of their businesses will cover promised payments.

Employees, for their part, will want assurance that their compensation will be there for them. One method of providing assurance is to set up a rabbi trust, which is a type of escrow account that provides some protection for the deferred compensation funds in the event of a hostile takeover or other type of management change (but is not protected from the claims of the employer’s general creditors). The protected funds may be invested in many ways, for example in mutual funds and in individual stocks and bonds, or may be used to purchase life insurance or annuity products. (Investors should be aware that investment returns and principal values of mutual funds and other securities will fluctuate due to market conditions. Therefore, when shares are redeemed, they may be worth more or less than their original cost.)

As Americans take on more responsibility for funding their own retirement, NQDCs may become a standard component of benefit packages. Because these plans are not governed by federal pension laws, they can be extremely flexible. Their very flexibility—and their associated risks— however, mean that you should seek professional counsel from tax, legal, and financial professionals prior to implementation.

If You Were Furloughed, Do You Have Cash?

The partial government shutdown resulting in 800,000 federal workers across the county not receiving pay is a wake up call. If you are lucky enough not to be one of those employees, or one of those contractors and supporting jobs affected by the shut down, this event should raise a question in your mind about your emergency fund. Typical guidance says 3-6 months of expenses. As far as rules of thumbs that is a good choice but further analysis can refine that number and make your personal financial situation more secure.

This begs the question of how much cash you should maintain for life’s emergencies – a job loss, a big medical bill, a legal liability or a government shutdown. The answer might surprise you. As will knowing that the older you get, the more you need.

Early in adulthood, we need lower emergency cash savings. Then life gets more complex. You likely have more people who rely on you, and so the risks of job loss are greater. Maybe you work in a cyclical industry or are self-employed. This involves parking a chunk of your income in cash instruments: bank savings accounts, certificates of deposit (those without long maturities so you can access your money more easily) and Treasury bills.

Here’s a recommendation of how much cash to have:

Young Adults

For individuals, couples or families just starting out on their financial journeys, three months is the bare minimum. But you may need to achieve this goal through slow and deliberate savings. Start by setting aside $10 to $20 per month and living within the remainder. If you can do more, do more. Increase this as you are able, but keep it right at the edge of your comfort zone and only dip into the savings for true emergencies.

Middle Years

When you are in the middle of your working life – say, 35 to 60 years old – you probably are busily investing to meet goals like retirement and college payments. Meanwhile, there is the added risk of job loss, or perhaps simply job dissatisfaction. You may want to make a change before it is too late. Odds are you have a family to support. You need a bigger safety net: six to 12 months.

This safety net pays for living expenses while you are out of work, or if you change direction and quit a job. Some refer to this as F.U. savings, for when you just can't take your boss for one more day. This is more and more important as companies maintain profitability through layoffs. People are working harder to keep their jobs. Even if you never use the emergency money, having it gives you financial confidence.

Nearing Retirement

When you are nearing that magical moment of maximum freedom, retirement (meaning approaching age 65), keep one to two years in safety money. This is because, with pensions sparse, your entire future retirement income is probably tied up in assets invested in unpredictable markets.

It’s easy to think that this 10-year bull market – which may or may not be ending – will continue forever. After all, last year was the first year in a decade that saw the S&P 500 dip into negative territory. But remember what happened 10 years ago? The market plunged 37% in a single year.

You need a buffer to protect you and keep your plans on track – a place to draw from not subject to market fluctuations. Otherwise, a major market drop may force you into taking a later retirement.

In Retirement

Ideally, once retired, you need a minimum of two years of emergency savings ready, just in case markets take a major tumble.

When people hear about building emergency savings, this is often the objection: “There is no return on these safe assets.”

True, cash returns are incredibly low these days, almost non-existent. But remember, given the uncharted waters we are in economically, it makes sense to enhance our safety nets.

You might be a huge optimist, and believe the future will be incredibly rosy. Still, you won’t know when those big temporary setbacks will occur – but they will occur. So, you should plan for them to arrive when you don't expect them.  

Another objection: “Taking care of both investments to meet life goals and a large safety net requires even more of one’s income.”

The answer to this: Yes, absolutely.

Sure, it’s true that if you don’t fund your safety net, you can divert more money into a higher standard of living for today or into greater investment assets for tomorrow. But eventually, something will happen in your life, an event that calls for a sum of cash waiting patiently on the sidelines.

Your comprehensive financial plan should allow you to see the wisdom of a balanced approach that includes a sizable safety net. If it doesn’t, then it’s not comprehensive.