When Paul and Eileen Clements of Putnam Valley, N.Y., decided to purchase a vacation home, they figured that renting it out could help them with expenses. "In the back of our minds, we were looking at properties that we knew would be attractive to renters," Paul says. In addition to rental income, a vacation home can also provide significant tax deductions.

Your second home doesn't even have to be built on a foundation to provide a tax shelter. The Internal Revenue Service says anything that features basic living accommodations, including space for sleeping, cooking facilities, and a toilet, can count as a second home. So in some instances, a boat or RV can qualify.


Use it, rent it, or both

What expenses are deductible? The answer depends on how much you use the home and how often you rent it out.

Keeping it to yourself. If your personal use exceeds 14 days a year and you rent the home out for two weeks or less, the IRS considers it a vacation home. Fall into this category and you can write off points paid on the mortgage over the life of the loan, real-estate taxes, and interest on qualified mortgage debt up to $1 million used to buy, build, or improve a home (on first and second homes only). You can also deduct interest on home-equity loans up to $100,000 used for other purposes. If you reach those limits on your primary home, though, your getaway won't gain you anything in this area, notes Mark Luscombe, principal tax analyst at CCH, a publisher of tax, accounting, and legal information. (Different rules apply if you pay the alternative minimum tax, so consult a tax pro.)

A bonus: You can rent out any home used as a residence (personal use of more than 14 days) for up to two weeks a year without paying income tax on the rental income, no matter how much you make.

Somewhere in the middle. Things get a little more complicated if you rent out your place for more than two weeks and use it 14 days or 10 percent of all rental days, whichever is greater. You can still write off points, mortgage interest (subject to the same limits mentioned earlier), and property taxes, but deductions must be allocated between rental and personal use.

Expenses that relate exclusively to your rental business, such as broker commissions and advertising costs, are fully deductible, but only up to the amount you earned in rental income. All other household expenses, including maintenance, repairs, and insurance, must be allocated and are only deductible in relation to the portion of time the home was rented. For example, if you had renters for just one month of the year, you can deduct only 1/12 of your expenses. You can carry forward any expenses not used in the current tax year to use in future years.

"We've been able to deduct a portion of everything from mortgage interest and taxes to plowing, firewood, dues, and maintenance for the house," Paul Clements says.

Rent-free time spent by family at the property usually counts as personal use, as do below-market rentals to friends. But time you spend at the home making repairs isn't seen as personal time.

Use less, gain more. Limit your personal use to fewer than 15 days each year and you'll get the greatest tax benefit. "You can still deduct all of the expenses associated with that property as a rental, and you don't have to allocate any of the expenses to personal use, so you don't lose any of the deductions," Luscombe says.

You might even be able to deduct losses in excess of the income you earn on your rental property. If you actively manage a rental, you can deduct up to $25,000 in losses against other nonpassive income, such as your salary. To qualify, you'll need to own at least 10 percent of the rental property and make what the IRS calls "management decisions in a significant and bona-fide sense."

This applies to taxpayers who have an adjusted gross income of less than $100,000 for a married couple filing jointly. If you earn between $100,000 and $150,000, the deduction is phased out. If your AGI is more than $150,000, you can take deductions up to the amount of rental income earned for the year, and excess losses can be carried forward to future years. (See IRS Publication 527 for complete rules.)