A primer on second homes vs rentals:
Before buying a second home, it’s smart to know how owning a second property could impact your taxes. There are many second home tax benefits to consider, but they’ll vary based on how the IRS classifies the property — as a second home, an investment property, or a little of both. Here are the main differences:
A second home:
- Is occupied by the owner at least 14 days out of the year
- Is rented to others 14 days or fewer out of the year
An investment property:
- Is occupied by the owner fewer than 14 days out of the year
- Is rented to others more than 14 days out of the year
A mixed-use property:
- Is occupied by the owner more than 14 days out of the year
- Is rented to others more than 14 days out of the year
Second home tax benefits
As long as you occupy your second home for more than 14 days a year, you may qualify for these second home tax breaks:
Mortgage interest deduction
Single filers and married couples filing jointly can deduct mortgage interest up to a total of $750,000 from all properties they own, including a principal residence and their second homes. This is subject to change in 2025, when the Tax Cuts and Jobs Act is scheduled to expire. At that time it is expected that the $1 million limit will return.
Property tax deduction
You can deduct property taxes on all the properties you own, with a maximum deduction of up to $10,000 per tax return, or $5,000 if married filing separately. Keep in mind that this is included in the deduction for state and local income taxes (SALT), so you might reach that $10,000 quickly with your principal residence and be unable to deduct property taxes from a second home.
Tax-free rental income
The IRS does not require you to report any rental income you receive from renting out your second home if you rent it out 14 or fewer days each year. Some second home owners choose to rent out their second home for two weeks each year so they can use the tax-free income to offset maintenance costs or property taxes on a second home.
Home equity loan interest deduction
If you take out a home equity loan or home equity line of credit (HELOC) on your second home and you use the money for home improvements on that property, you can deduct the amount in interest you paid on that loan from your taxable income for the year. Saving all your home maintenance receipts will provide evidence for this deduction if needed.
What you can’t use as a tax deduction on a second home
You may have heard about certain real estate tax deductions and wonder if they’ll apply to your second home. Here are a few tax breaks that don’t apply to vacation homes:
- Loss
- Operating expenses/repairs
- Rental expenses (for the 14 or fewer days rented)
Investment (rental) property tax benefits
The IRS requires you to report any income generated from a second home if you rented it out for more than 14 days out of the year. Its rental property status may qualify you for these investment property income tax benefits:
Rental expense deduction
Rental expenses include maintenance, property management fees, pest control, HOA fees, mortgage interest and property taxes. These are all considered operating expenses for you to maintain a rental property and, as such, they are deductible from the rental income you receive from the property. Mortgage interest can be deducted up to $750,000 if you are a single filer or married filing jointly, and up to $375,000 if you are married and filing separately.
Depreciation deduction
Owners of rental properties are allowed a depreciation deduction to help you recoup money lost in the building through normal wear and tear over time. The deduction is based on 80% of the value of the building alone (not the land that it sits on). Divide the building’s value by 27.5 years to approximate your annual depreciation deduction. Keep in mind that if you sell you may be charged a depreciation capture: You will be taxed on all depreciation deductions received over the years. To avoid this penalty, consider a 1031 exchange (see “Selling and capital gains tax” below for more information).
Loss deduction
If the annual income from your investment/rental property falls short of the amount you spent to maintain it during the year, you may be able to deduct the loss (up to $25,000) on your income taxes, depending on your adjusted gross income (AGI). If your AGI is less than $100,000 before deductions and exemptions, you may qualify for a loss deduction.
Taxes for a mixed-use property
If you’re occupying your home for part of the year and renting it out for another part of the year, the tax rules of both second homes and investment properties will apply to you, based on the ratio of time the home is used by you vs. the time it has been rented out.
For example, let’s say you used your second home for 30 days out of the year, and you rented it out for 70 days. (The other 265 days it was unoccupied.) In that case, 30% of your financial activity related to the home would be subject to second home tax laws, while 70% would be subject to investment property tax laws. (It’s a lot like the difference between taking your family out to eat vs. taking a client out to eat — one would be considered a non-deductible personal expense, while the other could be considered a tax-deductible business expense.)
Selling and capital gains tax
Just like tax deductions, taxes on the sale of your second home will depend on how it is classified, whether it’s a vacation home, investment property, or a combination of a personal residence and rental property.
Selling a vacation home
When selling a vacation home, you will be responsible for paying the capital gains tax on the entire profit you make from the sale, unless you make it your primary residence for at least two of the five years before you sell it. However, if you use this capital gains deferment on another primary residence during the two-year period before the sale of your second home, you are not eligible to defer.
Selling an investment/rental property
You may defer the capital gains tax when selling a rental property using a tool called a 1031 exchange. If you have owned the property for at least two years and plan to purchase a similar property right away, then the 1031 exchange allows you to defer the payment of a capital gains tax on the profits received from the sale. However, the new property must be identified within 45 days of the sale of the old property and in your possession within 180 days.
Selling a mixed-use property
Using a 1031 exchange to defer capital gains tax on a mixed-use property depends on the ratio the property was used for personal enjoyment vs. the number of days it was rented out. If it was used for personal enjoyment less than 10% of the time it was rented, then you may qualify for the capital gains tax deferment strategy that applies to investment properties.
The bottom line on second home taxes
Many second home tax benefits are similar to those of a primary residence, but depending on how you use the property, you may be able to claim a few additional perks as well. Be sure to consult a licensed tax professional to better understand how second home tax laws might affect you come tax time.
Great info! Thanks for sharing.