Slide 5-1 Tax Treatment of Vacation and Second Homes CHAPTER 5

Slide 5-2  Vacation home  Investment property  14-day rental rule  Passive activity  Active participation Tax Terminology Do not to give legal or tax advice. Advise clients and customers to seek professional advice.  Material participation  Cost recovery, depreciation  1031 exchange  Real estate professional (IRS definition)

Slide Day Rental Rule  Under 14 days a year  Don’t have to report or pay tax on income  No tax deductions  More than 14 days or 10% of time rented  all income is taxable  Deductions offset rent-related portion of expenses If rented year round, the IRS will regard it as a rental property If not rented or owner- occupied, the IRS calls it an investment property A Tax-Free Windfall? Determination is per property, not per owner. All co- owners’ use counts toward limit.

Slide 5-4 Deductible Expenses Personal Residence  Interest on mortgage debt, points, and fees  Real estate taxes  Casualty and theft losses Rental Property  Interest on mortgage debt, points, and fees  Real estate taxes  Casualty and theft losses  Depreciation  Advertising  Cleaning, repairs, and maintenance  Insurance  Commissions  Tax preparation fees  Travel and local transportation expenses ?

Slide 5-5  Modified Accelerated Cost Recovery System (MACRS)  27.5 year depreciation period Cost Recovery Recovery of the cost of the property and improvements over time  Structures only, land is never depreciable  Deductions are recaptured on sale and taxed at 25% ?

Slide 5-6 Converting to Personal Use  About 1 in 3 properties converted  Loss of expenses deductions  2 year residency reclassifies property as a personal residence, eligible for $250K/$500K exclusion of gain  Deductible portion of gain prorated between personal and rental/investment use

Slide 5-7 Owners can mail letters to themselves and their accountants stating the desire to switch the use of the property. Document the Repurposing

Slide 5-8 Capital Gain Tax on Sale of a Converted Home  Effective 1/01/09  Sale of a primary residence used as a 2 nd home (non qualified use) after 1/01/09 cannot claim full $250K/$500K gain exclusion  Taxable portions of gain based on % of non qualified use

Slide 5-9 Example Gain X Non qualified use = Taxable Gain Entire period of ownership after 1/01/09 Ownership or use prior to 1/01/09 does not figure in calculation ?

Slide 5-10 Residence Received in an Exchange  Own for 5 years  Rent for 2 years to maintain exchange eligibility  Occupy for 2 years to reclassify as a personal residence Remember capital gains tax after 1/01/09