Every week, Mansion Global poses a tax question to real estate tax attorneys. Here is this week’s question.
I’m a U.S. resident buying a second home in the country for the first time. What are the tax implications?
Both U.S. citizens and those with U.S. permanent resident status are subject to the same taxes, said H. Michael Soroy, of the Law Offices of H. Michael Soroy in Los Angeles. This includes property, income and capital gains taxes.
Property taxes are deductible in full on all homes, including second homes, Mr. Soroy said.
As for income tax, the Internal Revenue Service allows mortgage interest to be deducted, up to $1.1 million in combined debt. That’s $1 million for mortgages and $100,000 for home equity lines of credit, not $1.1 million on each home, no matter how many you own, emphasized Michael A. Gillen, director of the Tax Accounting Group at Duane Morris, a Philadelphia law firm.
Still, “with the maximum U.S. income tax rate around 40%, the tax savings can be meaningful,” he said.
Just be aware that buying a second home may increase your debt load. Interest paid on mortgage debt exceeding the $1.1 million mark is not deductible, Mr. Soroy advised.
If you rent the home out for 14 days or less during the year, you don’t need to report the income. “The cash is all yours, free of any U.S. income tax. And you can also deduct mortgage interest and property taxes just as you do for your main home,” Mr. Gillen said.
But when rentals exceed 14 days, you do have to report the income.
Upon the sale of the home, “all profit is generally taxable for U.S. income tax purposes,” Mr. Gillen said. U.S. tax law allows married couples to claim up to $500,000 ($250,000 if single) of profit tax-free from the sale of their principal residence. But this doesn’t apply to a second home.
“However, there is a way to extend the break to your second home by converting it to your principal residence before you sell it,” he said.
Some retirees, Mr. Gillen said, are selling the big family home and moving into what was once their second home. As long as one member of the couple lives in the home for two years, married couples can claim as much as $500,000 of profit tax free when they sell the former second home.
If you are not a U.S. citizen but rather a permanent resident in the United States and you move abroad, property you still own in the U.S. at the time of death could cause tax implications, Mr. Soroy said. The federal estate tax exemption is currently $5.49 million per person for U.S. citizens and permanent residents, but it’s only $60,000 for a permanent resident who no longer resides in the United States.
For your U.S.-based estate to gain the full exemption, he said, “a common approach is to set up a living trust that would hold title to U.S.-based assets and appoint a U.S.-citizen co-trustee (e.g. a bank or professional fiduciary),” he said.
Buyers planning to purchase a second home, and perhaps even a third or fourth home, should seek professional tax advice, because “your situation will likely become exponentially more complex,” Mr. Gillen recommended.
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