Don't Mess With Taxes

When one of our air conditioning units died last month, I got to thinking about how nice it would be to have a summer vacation home in the cool mountains.

I'm not talking about a mega-bucks chalet like the rich and famous have at Sundance or Aspen. A nice little place in Ruidoso, N.M., is fine by me.

When I was a kid, my family used to occasionally take a vacation break there to escape the summer heat. One of my dad's coworkers had a cabin and we got to use it. It wasn't really a cabin in the rustic sense; rather, it was a basic suburban house in a neighborhood built to attract seasonal residents.

But we also liked to say we were going to the mountain cabin. And I loved it. To this day, any time I smell pine trees, childhood memories of those Ruidoso retreats come back vividly.

We ate at the Whispering Pines buffet, always buying a loaf of its freshly baked bread to take back to the cabin for sandwiches later.

We hiked up the neighborhood hillside to gaze out at the valley below.

We saw bears wandering the block when we'd come home from a late dinner or after a movie.

Fish and cut bait: And once, when I said I wanted to go fishing, we went to Rainbow Lake, where my brother and I "caught" a couple of rainbow trout.

I'm pretty sure that was the name of the place, although my quick Googling didn't turn up anything that looked remotely like what I remembered. Similarly, no trace of the Whispering Pines restaurant, only some real cabins by that name. Of course, that was a few (OK, quite a few) years ago, and time does indeed march on.

Anyway, the Rainbow Lake of my memory was a big cement reservoir full -- overfull actually -- of, what else, rainbow trout. You could buy small bags of fish food, toss it in the pool and watch the whole place vibrate as every trout went after the pellets.

Actually, it was kind of creepy. And the fishing wasn't really fishing. The fish were so conditioned to eating anything that hit the water, you could have dropped an unbaited hook (and maybe we did) and several of them would have latched onto it.

What I had meant when I told my dad that I wanted to go fishing was that I wanted to sit under a tree alongside one of the creeks we passed as we came and went from the cabin neighborhood. I really had no desire to catch anything. I just wanted to drop a line, sans hook would have been fine, and leisurely enjoy the outdoors.

But I didn't explicitly say that. And my dad, bless him, wanted to make sure that I wouldn't be disappointed if we went fishing and I didn't catch anything. So he took us to Rainbow Lake.

I never did sit under a tree with a pole that, or any other, Ruidoso vacation.

But that's OK. If I had actually accidentally caught a fish that way, I'm not sure any of us would have know what to do. I would have probably thrown it back, along with the pole, hook and line, into the stream!

And the Rainbow Lake way, the employees took care of all the messy stuff, including cleaning the fish, so all my mum had to do was fry it up. Not a bad vacation dinner, home-cooked fresh fish accompanied by the newly-baked Whispering Pines bread.

Second home tax advantages: When you own a second home, mountain cabin or beach house or wherever, it offers some tax advantages.

According to the IRS, the mortgage interest on a second home which you use as a residence for some portion of the taxable year is generally deductible. So are real estate taxes paid on that second residence.

For more information, the IRS refers you to the mortgage interest deduction section of Publication 17, Your Federal Income Tax for Individuals; Tax Topic 503, Deductible Taxes; and the qualified home section of Publication 936, Home Mortgage Interest Deduction.

What if you rent the place, at least some of the time? Special tax rules apply here, too, including one that lets you pocket the rent money tax-free if you only have paying guests for 14 days or less a year.

Details on this and other second home tax situations can be found in these releases from RIA Thomson and the National Association of Tax Professionals.

Vacation home tax drawback: One downside of second homes, though, is that when you sell them, you don't get to exclude any profit. You'll owe the IRS money at the applicable capital gains rate.

In some real estate situations, people try to put off these tax payments by doing a 1031 exchange, also known as a like-kind exchange. You basically exchange your property for a similar one and then don't owe taxes until you ultimately dispose of that exchanged property.

But don't try that with a vacation or any other personal real estate. Only business or investment property qualifies for a tax-deferred swap. The U.S. Tax Court reiterated that recently, with a ruling that invalidated a Georgia couple's attempt to postpone taxable gain on a personally used second home by swapping it for another house.

Since the couple never rented the home to others, the court ruled the exchange a taxable sale.

Here's the court's ruling. As you'll see if you decide to give it a read, the ruling underscores the need to hire a good real estate lawyer or a tax adviser/accountant who has property taxation expertise if you're considering buying a vacation retreat.