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In mid 2015 I purchased a house with the intention of completely renovating it and renting it out. The renovation is now complete with approximately half of the renovation cost incurred in 2015 and half in 2016.

Half of my total renovation costs were financed (i.e., part of my mortgage) while the other half I paid in cash out of my pocket.

No tenants have occupied the house yet and no rental income has been received.

My big question is:

Should I treat this house as a second home or a rental property on my 2015 taxes?

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.

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.

This makes it seem like treating the house as a rental property is clearly the better option. However, I do not know what would happen to my mortgage interest deduction if I treat the house as a rental property.

According to the IRS, mortgage interest on a rental property can be deducted. But does mortgage interest get deducted against my total income or only my rental income? If it's the latter, and I don't have any rental income yet, does that mean I can't deduct any mortgage interest?

If I treat the house as a second home, then I know I would be able to deduct 100% of the mortgage interest I pay on this house because my total mortgage debt is under $1.1 million.

Any guidance would be much appreciated!

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  • Welcome to Money.SE. A DV is rarely followed by a comment explaining. +1 from me as this is a decent question.
    – JTP - Apologise to Monica ♦
    Mar 2, 2016 at 0:32
  • did you ever live in the house?
    – mhoran_psprep
    Mar 2, 2016 at 3:00

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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.

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  • Thank you for your reply, very very helpful. It wasn't available for rent in 2015, so I suppose that would make it a personal use second home for 2015. I'd prefer to depreciate the cost of the renovation. The house will be rented in 2016. Half of the renovation costs were incurred in 2015 and the other half in 2016. If I claim the house as a personal use second home for 2015, could I depreciate the renovation costs incurred in 2015 as well as in 2016 for my 2016 taxes? Or could I only depreciate the renovation costs incurred in 2016 and the 2015 renovation costs go towards my cost basis?
    – Elliot B.
    Mar 2, 2016 at 5:47
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    @ElliotB. you can only depreciate assets that are in a income-producing activity. That means that you can only depreciate your house once you start renting it out. That includes the whole house, not only the renovations.
    – littleadv
    Mar 2, 2016 at 5:48
  • Ahh, that makes sense. So for 2015 taxes I'll have to treat it as a second home. For 2016 taxes, when it's producing income, it gets treated as a rental, I determine my basis in the building (not land) inclusive of the renovations, and then depreciate that over 27.5 years.
    – Elliot B.
    Mar 2, 2016 at 5:56
  • @ElliotB. you got it.
    – littleadv
    Mar 2, 2016 at 6:01

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