That vacation retreat untouched by tax shift - unless it's a shelter

In a few months, thousands of Americans will take the shutters off their summer cottages, air the places out, and restock the shelves with potato chips, soda, and suntan lotion. Meanwhile, many other Americans are closing up their ski-resort cabins, taking home their boots, jackets, and hot chocolate.

For both groups, there's an extra piece of baggage to carry along this year: concern about whether tax reform will make a vacation home less affordable, perhaps even forcing the owners to sell.

To answer that question, real estate experts say, you have to decide whether you are using the second home for vacation only, as a second source of income, or as a tax break. For the vast numbers of people for whom these are simply second or vacation homes, and who don't rent them out, there will be almost no change. Congress left the full deduction for property taxes and interest for first and second homes.

``There's a clear distinction between rental property and property held for personal use,'' says Jack Walsdorf, a vice-president and manager of direct investments at the Advest brokerage. ``If it's for personal use, there's no problem with the deduction for interest or taxes.''

That deduction, however, may not be worth as much, depending on your tax bracket. If you were in the 50 percent bracket last year, you could deduct half of the home taxes and interest. This year, with the top bracket at 38.5 percent, your tax savings are socked with a corresponding decline. Next year, with the top bracket at 28 percent, the savings will be that much less.

For some taxpayers, however, the lost savings won't be that bad. If they filed a joint return for 1986 and had an adjusted gross income of less than $68,000 - which covers a lot of people who have bought a second home for retirement - they were still in the 38 percent bracket or under.

For others, who bought vacation homes primarily for tax benefits, or who use the home part of the year but rent it out the rest of the time, the new tax rules have complicated the view considerably. And it could get worse.

``The tax break for second homes is the most vulnerable part of the tax code,'' says Tom Lechner, vice-president for real estate development at Prescott, Ball & Turben, another brokerage. ``It's probably the least justified deduction there is outside of consumer interest on credit cards. It doesn't take too many congressmen [from working-class districts] asking, `Why we are letting people deduct a cottage on Cape Cod when we have a $225 million deficit?'''

Those who buy second homes in areas that are not overbuilt and who enjoy the extra income from rents, regardless of the tax breaks, also have nothing to fear from tax reform, Mr. Lechner says. ``People will still buy, if they make sure that it makes economic sense and forget taxes.''

An acquaintance of Mr. Walsdorf's confirms this view. This friend, he says, sells vacation homes near the ski areas of southern Vermont. ``He reports no decline in sales,'' Walsdorf reports.

If you rent out your second home much of the year, you will have to decide whether to start using the home yourself more, so you can claim it as a second residence, or whether to continue renting to claim the loss as a business venture.

If you rent the place and have an adjusted gross income of $100,000 or less, you can claim up to $25,000 of ``passive'' losses - such as depreciation, repair costs, and utility bills - against your regular income. If you make between $100,000 and $150,000, the amount of losses you can claim gradually diminishes.

To qualify as a second residence instead, you must stay there at least 14 days a year, or 10 percent of the time it is rented, whichever is longer. If you use the house less than that, mortgage interest will be viewed as personal interest, which, like credit card interest, is losing its deduction.

The problem comes if you use the place more than 14 days. Then, it becomes a second residence and you can't claim any losses, while your deductions only offset your rental income. Deductions for property taxes and mortgage interest have to be spread between rental and business use, while deductions for depreciation and expenses can be claimed only against leftover rental income.

Because 1987 is a transition year with a 38.5 percent top rate and a year when 65 percent of passive losses and personal interest can still be deducted, it will pay high-income taxpayers to rent their second homes and claim them as business expenses. Next year and after, it will probably make more sense to use the property as a residence and claim the mortgage interest.

The final decision will hinge on whatever mortgage interest you pay relative to the rental income you receive. An accountant or tax adviser can help you figure out how the balance works for you. But if you are just keeping the house for your own use every summer and plan to live in it full time or sell it in several years, you can probably rest easy under the new rules.

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