Mountain vacation homes:
Think tax strategies before taking plunge

By Todd Harker, CPA Senior Tax Manager, Gordon, Hughes & Banks LLP, Vail & Frisco Offices

Owning a vacation home in Colorado conjures up dreams of a weekend getaway, with the siblings or extended family bonding on weekends, just like the old days at Grandma and Grandpa's cottage by the lake. In fact, according to the National Association of Realtors, sales of vacation or second homes grew 20 percent over sales in 2003, adding 1.02 million homes to the total of 6.6 million second homes. The typical buyer is the baby boomer in his or her mid-50s, and the homes cost on average just below $200,000.

In the mountain town communities of Avon, Vail, Breckenridge, Dillon, Frisco, Winter Park and communities in surrounding environs, the phenomenon of second homes has far-reaching economic implications: from providing primary and secondary jobs in construction, property management, hospitality and retail to bringing in more summer and winter tourists who add to the county coffers by spending freely. In Summit County alone, 67 percent of homes are second homes.

Yet, there are several social and lifestyle downsides to communities with large populations of vacant homes - such as congestion and pollution in high season, the need for affordable housing for seasonal w o r k e r s , and escalating home prices that make it nearly impossible for the permanent locals to buy homes.

There are also tax consequences down the road when the aging owner wants to sell, because his or her children are not interested in the maintenance, or the siblings no longer live in Colorado, thus making it difficult or less attractive as a regular vacation destination. Then, family squabbles among siblings about who gets to use the home, or even whether they want to keep it or sell it, can create a vacation nightmare instead of a vacation dream.

So, when buying a vacation home, the wise buyer should try to plan three to five years in advance, and consider what ultimately will be done with it. Whether you rent it out, leave it to family members, or decide to sell in the next five, 10 or 20 years, all have important tax consequences.

For a buyer who is thinking about renting his vacation home, there are limits to the deductions he can take, based on how long he has owned the property and how many days he rents the property annually. If you rent your home for more than 15 days, you recognize rental income while being allowed deductions on certain items, depending on your personal use of the property. If you rent your second home for less than 15 days during a calendar year, not all deductions directly attributable to the rental are allowed, but you need not report any rental income.

If you wish to leave your home to family members, there are strategies to help freeze the value inside your estate. So, if you have concerns that your estate will pay taxes at up to 50 percent of the value, then removing the vacation home from your estate through gifting can provide a significant advantage.

Also, capital gains are a factor if you choose to sell. In 2003, Congress lowered the maximum capital gains tax rate from 20 percent to 15 percent. The lower rate expires at the end of 2008 and will rise to 20 percent in 2009. However, a creative solution with significant savings exists for those unwilling to pay high taxes, but willing to use their vacation home as a primary residence. The home-sale exclusion gives a single owner up to $250,000 of gain that can be excluded from the sale of a principal residence. A married couple can exclude up to $500,000. As with all deductions, there are certain provisions required:

You must show that your vacation home has become your principal residence, and you must have lived in the home for a minimum of two out of the last five years. To help justify your residence change, you should file income taxes from this address, be registered to vote in the area, and register any vehicles or boats with the local municipality. These are just a few of the items the Internal Revenue Service might look for to challenge residence.

A buyer who fulfills these criteria will save as much as $75,000 in federal taxes, or 15 percent of $500,000. With the home sale exclusion, vacation home owners can have both their proverbial cake and eat it too!

This article appeared in the Semptember 7, 2005 issue of The Colorado Real Estate Journal.