Cabin properties can be solid investments. In fact, there’s been a recent surge in cabin and vacation homeownership not just for the financial benefits, but also because they provide wellness opportunities and even provide great surroundings for remote workers. As with any investment, it’s important to understand the tax aspects of owning cabins.
Certainly, there will be a range of tax implications and responsibilities depending on how a cabin fits into your investment plans. Similarly, there can be some tax benefits that help mitigate the financial impact. Let’s explore a few of the useful areas of focus.
Making the Most of Personal Use Deductions and Credits
Let’s start with buying a cabin for personal use. This can be a great investment in your family’s quality of life, using it as a vacation property and regularly escaping the pressures of city living. Yet, it’s important to know that one of the tax implications of using it primarily as a personal second home tends to mean there aren’t as many deductions or credits compared to renting the cabin.
This makes it particularly important to identify and use as many of those deductions you are entitled to. These may include:
Mortgage interest
If the mortgage on your cabin meets certain criteria, you’re able to deduct the interest you pay. For cabins bought after 2017, the value of your debt cannot be more than $750,000 if you’re married and filing jointly. For individuals, the cap is $350,000.
Property tax
Depending on the location of the cabin, it may be subject to various state and local property taxes. As per the Internal Revenue Service (IRS) website: “Deductible real property taxes include any state or local taxes based on the value of the real property and levied for the general public welfare.” Married couples filing jointly can’t deduct more than $10,000 total, or $5,000 individually.
Energy efficiency improvements
Energy efficiency upgrades can not only see you paying less for your cabin’s utilities, but you can also claim certain tax credits. The Energy Efficiency Home Improvement Credit (EEHIC) can be particularly helpful. This is a credit you can claim every year you make energy efficiency improvements to your cabin up until 2033. It is capped at 30% of your improvement costs, up to $1500 each year for most upgrades or $2000 for heat pumps and biomass boilers.
Navigating Capital Gains Tax
Any profit you make from the rise in value between buying a property and selling it is considered taxable income by the IRS. As a result, you may not have as much of the money from the sale of your property to reinvest in a cabin as you’d like.
In most cases, this capital gains taxes are unavoidable. Yet, there are ways to navigate it to minimize negative financial impact. One effective tactic to use is a 1031 exchange. This refers to a section of the IRS code that allows those who are exchanging one property for another to arrange a deferment. Rather than simply paying the tax on the profits of a property sale, the government allows you to reinvest those profits in a cabin. The most common type of 1031 is a deferred exchange, which allows you 45 days from the sale of your property to find potential reinvestment cabins, and 180 days to close on the sale.
Remember, though, that this is a deferment, you’re not avoiding tax payments entirely. You’ll still need to pay your capital gains taxes when you eventually sell your property. Nevertheless, alongside minimizing immediate financial impact, the deferment can make it easier for you to benefit from the compound interest you can make from reinvestment. Filing the right paperwork — particularly IRS Form 8824, Like-Kind Exchanges — is vital. Working with a qualified intermediary can also help you ensure you’re always acting within the bounds of the IRS code.
The Impact of Rental Use
A cabin, like any investment, can be subject to economic fluctuations. Finding ways to protect your investments during times of inflation is vital. Alongside directly investing in real assets — like cabins — that tend to respond well to inflation, using real estate investment trusts (REIT) can also provide you with tradable securities that track physical assets. Diversity of investment is a useful strategy, too. For many cabin owners, this includes renting out their properties to gain passive income.
There are some tax considerations you’ll need to be aware of if you’re planning to rent a cabin. The primary one is that, alongside the capital gains tax you may have to pay when you eventually sell the cabin, you’ll also need to pay tax on the rent you charge.
Nevertheless, you can offset this with a range of deductions, including:
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Repair and maintenance costs: This includes charges for everything from mitigating wear and tear to addressing a leaky sink.
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Property improvements: Any upgrades and renovations to the property may qualify for tax deductions under IRS code section 179. It’s important to note that the section requires all items you seek deductions for must be used for business purposes at least 50% of the time.
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Guest service fees: Some cabin owners choose to use services, like Airbnb, to manage renting their properties. The fees charged for this can usually be deducted from your total rent income. The guest services provider must send you IRS Form 1099, which details the fees, which you can then include in your tax return.
Getting the tax deduction benefits as a landlord doesn’t necessarily mean your family also can’t enjoy the use of your cabin. If you make it available to rent for at least 14 days per year and don’t personally use it for more than 10% of total rental days, you can qualify for business deductions.
Conclusion
Investing in cabins can have both financial and lifestyle advantages. Making the most of these requires you to strategize your tax approach, including identifying relevant deductions and leveraging deferments. That said, tax can be complex. It’s always best to partner with an experienced tax advisor or intermediary to ensure you are behaving not just tactically but also legally.
