Renting out a vacation home

July 1, 2004
I recently purchased a vacation home that I plan to use for personal purposes. However, I recently heard that I could rent this out for two weeks each year...

Charles Blair, DDS and John McGill, MBA, CPA, JD

I recently purchased a vacation home that I plan to use for personal purposes. However, I recently heard that I could rent this out for two weeks each year and not have to report any of the income received. Is this correct?

Yes. Section 280A(g) of the tax law allows individuals to rent their personal residences (main or vacation home) for up to 14 days annually, without having to report the income. Moreover, deductions for mortgage interest and property taxes paid are still allowable.

Many doctors have rented their homes out to third parties for 14 days each year to take advantage of this tax-free income. In other situations, doctors have rented their homes to their professional corporations. As long as the corporation uses the residence for business meetings (board of director meetings, shareholder meetings, staff-training meetings, staff retreats, etc.), the corporation should be able to fully deduct the amounts paid and the income can be received by the doctor totally tax-free.

I have been maximally funding retirement plans for many years, but I am now contemplating early retirement. My insurance agent recommended investing in a whole-life insurance policy, since my retirement plan funds will not be available prior to age 59 1/2. What do you recommend?

We recommend continuing to maximally fund retirement plan contributions. These amounts are deductible for federal and state income tax purposes, and grow on a tax-deferred basis, with limited fees and expenses. Many doctors do not understand that these funds can be withdrawn prior to age 59 1/2 without penalty. For example, the doctor's retirement plan can be terminated, the funds rolled over to an IRA, and monthly payments taken over the doctor's life expectancy. While the amounts received will be subject to federal and state income taxes, they will avoid the 10 percent penalty otherwise applicable to distributions prior to age 59 1/2.

I have operated a regular "C" corporation for many years, but made a Subchapter S election effective January 1 of this year. For many years, I had had my out-of-pocket medical expenses reimbursed under the corporation's cafeteria plan. Now, my CPA has told me that "S" corporation doctors cannot use a flex/cafeteria plan to reimburse their out-of-pocket medical expenses for themselves or their family on a tax-free basis. Is this right?

Yes. Under Internal Revenue Code section 1372(a)(2), a 2 percent or more shareholder in a Subchapter S corporation is treated as a partner in a partnership. As a result, they are not eligible to participate in a cafeteria plan on a tax-free basis.

For these doctors, we recommend an insured medical-expense reimbursement plan. Under the new tax law, the insurance premiums paid on such a second plan are tax-deductible to the corporation, and the proceeds represent tax-free income to the doctor.

I have been incorporated for a number of years. Until last year, I was a regular "C" corporation, but converted to Subchapter S status on January 1 of last year. For many years, I had paid my disability insurance premiums personally. At the end of each policy year, the corporation would reimburse me for the premiums paid, provided that I was not disabled. I continued this last year when I became a Subchapter S corporation, but my accountant says that this tactic will no longer work. Is he correct?

Yes, he is. For doctors operating as a sole proprietor, limited liability company ("LLC"), general or limited partnership, disability-insurance premiums paid are not deductible. However, any disability-insurance proceeds received would be tax-free.

Only doctors operating as a regular "C" corporation can deduct disability insurance premiums paid through their practice. However, in the event the doctor becomes disabled in a year the premiums were paid through the corporation, all disability insurance proceeds would be taxable. Because of this, "C" corporation doctors may wish to continue the strategy of paying disability-insurance premiums personally and be reimbursed at the end of the policy year if they are not disabled. In the event of disability, no reimbursement would be made and the proceeds should be tax-free, since all premiums were paid personally for that year.

Dr. Blair is a nationally known practice-profitability consultant and a member of the American Academy of Dental Practice Administration. Mr. McGill is a tax attorney, CPA, and MBA, and is the editor of the Blair/McGill Advisory, a monthly newsletter helping dentists to maximize profitability, slash taxes, and protect assets. The newsletter ($199 a year) and consulting information are available from Blair/McGill and Company, 2810 Coliseum Centre Drive, Suite 360, Charlotte, NC 28217, call (704) 424-9780 or visit the Web site at www.bmhgroup.com.

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