Tax treatment of renovation costs and mortgage interest on a second house
Should I treat this house as a second home or a rental property on my 2015 taxes? If it was not rented out or available for rent then you could treat it as your second home. But if it was available for rent (i.e.: you started advertising, you hired a property manager, or made any other step towards renting it out), but you just didn't happen to find a tenant yet - then you cannot. So it depends on the facts and circumstances. I've read that if I treat this house as a rental property, then the renovation cost is a capital expenditure that I can claim on my taxes by depreciating it over 28 years. That is correct. 27.5 years, to be exact. I've also read that if I treat this house as a personal second home, then I cannot do that because the renovation costs are considered non-deductible personal expenses. That is not correct. In fact, in both cases the treatment is the same. Renovation costs are added to your basis. In case of rental, you get to depreciate the house. Since renovations are considered part of the house, you get to depreciate them too. In case of a personal use property, you cannot depreciate. But the renovation costs still get added to the basis. These are not expenses. But does mortgage interest get deducted against my total income or only my rental income? If it is a personal use second home - you get to deduct the mortgage interest up to a limit on your Schedule A. Depending on your other deductions, you may or may not have a tax benefit. If it is a rental - the interest is deducted from the rental income only on your Schedule E. However, there's no limit (although some may be deferred if the deduction is more than the income) if you're renting at fair market value. Any guidance would be much appreciated! Here's the guidance: if it is a rental - treat it as a rental. Otherwise - don't.
Advantages of buying: With every mortgage payment you build equity, while with rent, once you sign the check the money is gone. Eventually you will own the house and can live there for free. You can redecorate or remodel to your own liking, rather than being stuck with what the landlord decides is attractive, cost-effective, etc. Here in the U.S. there are tax breaks for homeowners. I'm not sure if that's true in U.K. Advantages of renting: If you decide to move, you may be stuck paying out a lease, but the financial penalty is small. With a house, you may find it difficult to sell. You may be stuck accepting a big loss or having to pay a mortgage on the empty house while you are also paying for your new place. When there are maintenance issues, you call the landlord and it's up to him to fix it. You don't have to come up with the money to pay for repairs. You usually have less maintenance work to do: with a house you have to mow the lawn, clear snow from the driveway, etc. With a rental, usually the landlord does that for you. (Not always, depends on type of rental, but.) You can often buy a house for less than it would cost to rent an equivalent property, but this can be misleading. When you buy, you have to pay property taxes and pay for maintenance; when you rent, these things are included in the rent. How expensive a house you can afford to buy is not a question that can be answered objectively. Banks have formulas that limit how much they will loan you, but in my experience that's always been a rather high upper bound, much more than I would actually be comfortable borrowing. The biggest issue really is, How important is it to you to have a nice house? If your life-long dream is to have a big, luxurious, expensive house, then maybe it's worth it to you to pour every spare penny you have into the mortgage. Other people might prefer to spend less on their house so that they have spare cash for a nice car, concert tickets, video games, cocaine, whatever. Bear in mind that if you get a mortgage that you can just barely afford, what do you do if something goes wrong and you can't afford it any more? What if you lose your job and have to take a lower-paying job? What if some disaster strikes and you have some other huge expense? Etc. On the flip side, the burden of a mortgage usually goes down over time. Most people find that their incomes go up over time, between inflation and growing experience. But the amount of a mortgage is fixed, or if it varies it varies with interest rates, probably bouncing up and down rather than going steadily up like inflation. So it's likely -- not at all certain, but likely -- that if you can just barely afford the payment now, that in 5 or 10 years it won't be as big a burden. Note that after 15 years, the tax exemption is €36800 per person, which includes both the principal you desposited and the accumulated interest.  It's possible that you will have a higher balance than this in your savings account at this point and would still owe tax on the interest accumulated above the exempted amount.  After 20 years, you get the full tax exemption, the lesser of your portion of the mortgage debt and €162000 per person. In direct answer to your questions: I'm not aware of any exceptions to the 15 year rule for allowing the accumulated interest to be tax free when selling your house.  If your accumulated interest is low enough, you might consider just paying the tax on it as it would give you the most flexibility in choosing a new mortgage.  This is why I asked about more details about your interest rate and how long the mortgage has been running. It may, however, possible to couple the savings account to a new ABN AMRO Bankspaar mortgage when you buy a new house.  You should check your mortgage terms and conditions.  For example, Section 23.12 in ABN AMRO's terms and conditions from 2010 describes this.  See here.  It is probably best, however, to speak directly with either your mortgage broker or with a mortgage adviser with ABN AMRO.  If your mortgage broker still worked on commission (aflsuitprovisie) when you closed your mortgage, then they are obligated to assist you with this type of question. In order to qualify for the tax exemption, you must use the saved value to pay off debt on your primary residence (eigenwoningschuld).  Decoupling the savings account entirely from a mortgage will disqualify you from the tax advantages.  You will owe tax on all accumulated interest. I agree with MrChrister about first considering how necessary the renovations are (is it a nice-to-have, or a need-to-have?), as well as the importance of consulting a Realtor, if you are selling your home, as they will advise you wisely.  For instance, they might advise you to replace the linoleum with a neutral beige ceramic tile, as you would be assured a better resale value on your dollar spent, than if you were to replace the old linoleum with new linoleum (or laminate). There are many types of renovations that simply don't pay off, and others that do provide good return-on-investment (like intelligent kitchen and bathroom updates).  I found this ROI grid at lendingmax.ca (which is pretty consistent with what I remember reading in the Toronto Star this spring): Top 10 Renovations ~ Average return   on investment Painting and interior decorating = 73% Kitchen renovations = 72% Bathroom renovations = 68% Exterior painting = 65% Flooring upgrades = 62% Window/door replacement = 57% Family room addition = 51% Fireplace addition = 50% Basement renovation = 49% Furnace/heating updating = 48% If you are selling your home, and your Realtor has suggested improvements, they are probably necessary, and not doing them might serve as an impediment to quickly selling your home - so factor in the (potential) costs of carrying your home for additional weeks/months, or worse, overlapping mortage costs, if it takes your home longer to sell, and you end up owning two homes simultaneously for a bit. As far as your question (should you pay cash for renos or take out a loan), one factor to consider if you live in Canada is the Home Renovation Tax Credit, which applies to renos that take place until Feb 1, 2010, and can deduct up to $1,350.  So if you have to do a reno and yours qualifies for this tax credit, and you won't have the cash before that deadline, factor in the cost of borrowing vs. the $1,350. Good luck! You have a loan. You can probably assume you're going to have to repay that loan, every dollar. And every dollar that's outstanding on that loan costs you interest. So assuming you're not hit by any pre-payment penalty, any dollar that you pay down on your house right now saves you a compounded R% a year, where R is your mortgage rate. It doesn't really matter whether you're planning to sell it in a few years or not. If you pay $N, you'll save the interest + $N taken from the sale price and sent to the bank when you sell the house and move (though you might get a tax deduction on the interest). If you have a better place to park your money and earn a decent rate of return, it would be worth it to do that instead of paying down the mortgage. If you had another loan with higher interest rates, that's probably a better loan to pay off. If you can spend some of all of it on something that's actually genuinely worth R% of its purchase price a year (plus whatever the wear and tear takes away from its value, if anything) then spend it on that instead; that'd be a better investment. (For instance, investments in the stock market may offer better returns. However, that's risky! Observe that you can't lose money paying down your mortgage, and that Safety is usually relatively expensive these days, so it's not a bad deal. But if you're talking about using it for long-term retirement savings that are tax-advantaged to boot, that's another matter.) If you already have ample emergency funds and were just planning on putting the money into a savings account to rot at ~1.35% taxable interest, it's definitely worth it to pay down your balance now, unless you're about to sell (so the savings are slight) and it's a real inconvenience. There is no relationship between the government appraisal and the mortgage appraisal.  The loan appraisal is done by a lender to determine if the property value is in agreement with the loan amount. The government appraisal is done to determine how much to charge you in taxes. They use the values of residences and commercial property to get their operating budget each year. They also set the rate to generate the amount of income money they need. If they cut all appraisals in half, they would just double the rate. In some jurisdictions the government appraises every year, in other places every three years. Some only when the property is sold. In some jurisdictions the maximum increase or decrease in government appraisal is set by law. But then they reset after the house is sold. That being said. Use this time to review the appraisal from the government. They may have facts wrong. They may think you have a pool, or more bedrooms or a garage, when you don't. Some jurisdictions use an automated process, others do a more detailed/individual process. If there was a mistake ten years ago with the description it will never get caught unless you complain.  Check with the governemnt website for how to appeal. Some have windows of opportunity for an appeal. You need an accountant and/or a lawyer who is familiar with the US tax code and the rules in South Korea (assuming from your tag). As the interest will be money generated in the US, you could be required to withhold some of the interest and remit it to the IRS (I believe 30% withholding rate). Since South Korea is a treaty country, your friend can complete and sign a form W8-BEN and give it to you, so you may withhold a lower amount. Your friend would need to file a return if too much was withheld. They may also get taxed in South Korea. There are probably rules in South Korea about minimum interest that must be charged, similar to Applicable Federal Rates for the US, so check with your accountant or lawyer for this. If you craft it correctly, you will be able to have a loan as a mortgage (with the house properly secured), which then would allow you to deduct mortgage interest rates from your return. As far as I am aware, there is no maximum amount for loans. Many states have a simple method for assessing income tax on nonresidents.  If you have $X income in State A where you claim nonresident status and  $Y income overall, then you owe State A a fraction (X/Y) of the income  tax that would have been due on $Y income had you been a resident of State A.  In other words, compute the state income tax on $Y as per State A rules, and send us (X/Y) of that amount.  If you are a resident of State B, then State B  will tax you on $Y but give you some credit for taxes paid to State A. Thus, you might be required to file a State A income tax return regardless of how small $X is.  As a practical matter, many commercial real-estate  investments are set up as limited partnerships in which most of the annual taxable income is a small amount of portfolio income (usually interest income that you report on Schedule B of Form 1040), and the annual  bottom line is lots of passive losses which the limited partners report (but do not get to deduct) on the Federal return.  As a result, State A is unlikely to come after you for the tax on, say, $100 of interest income each year because it will cost them more to go after you than they will  recover from you. But, when the real estate is sold, there will (hopefully) be a big capital gain, most of which  will be sheltered from Federal tax since the passive losses finally get  to be deducted.  At this point, State A is not only owed a lot of money (it knows nothing of your passive losses etc) but, after it processes the income tax return that you filed for that year, it will likely demand that you file income tax returns for previous years as well. Why doesn't it seem right to you? The lender financed the house and has the first right claim (mortgage) on it, so if you have any insurance proceeds they're first offsetting your debt to the lender. Same as if you were selling the house - first the loan is paid off, whatever is left goes to you. If the property is not lost, then the proceeds are going to you and you keep paying the mortgage. So if a pipe burst and you need to replace the flooring, the insurance will cover it, and you'll get the proceeds. If the building is lost and you're paid the fair market/rebuild value, then you first need to pay off the mortgage. Its standard.