The IRS produces Publication 527 for investors of residential rental properties, which includes vacation properties. The guide gives investors all the information they need when filing their tax return - including sections regarding rental income, expenses, depreciation, etc. It's indispensable whether you use an accountant or not. This is information you need to know if you're going to be investing in rental properties of any kind.
Depreciation is one of the best tax deductions available to real estate investors. Essentially a write-off against taxable income, it is based on the useful life of a property. All buildings have wear and tear, and rental properties depreciate on a straight-line basis over 27.5 years.
If you are using the property for commercial purposes, it depreciates over a 39-year period. The land doesn't depreciate. For example, if a property is worth $500,000 with the land worth $100,000, $400,000 depreciates over 27.5 years. That's a tax deduction of approximately $14,500 every year against your taxable income. It's important to note that the depreciation will be recaptured when the property is sold. However, when all is said and done, you'll be ahead financially.
It's important to note that depreciation applies not only to the property but also to any of the equipment used in the unit as well. The appliances (fridge, stove, washer and dryer, etc.) depreciate over a shorter period, usually five years on a straight-line basis. In addition, in certain circumstances you can depreciate 100 percent of the cost of the equipment in one year as opposed to the usual five if the assets acquired are for business purposes at least 50 percent of the time. In 2007, up to $112,000 in write-offs against other income is available. If you've had an especially good bonus, this deduction could be extremely valuable.
Another tax tip is the 1031 tax-free exchange. Section 1031 of the Internal Revenue Code states that you pay no taxes if you reinvest the proceeds from a sale in similar types of real estate. In essence, as long as you don't pocket the funds, you'll continue to defer the taxes payable until such time as you do. As you can see, investing in rental properties is an excellent way to grow your assets and defer taxes.