Many homeowners look forward to purchasing a second home that can be used for vacations, rental income, investment purposes or as a primary residence during retirement.
Current tax laws offer several tax breaks that can help make second-home ownership more affordable.
If it’s financially feasible, owning a second home can be an excellent investment for vacation or rental purposes, or to use as a primary home during retirement. Because owning any home carries a significant financial burden – from mortgage and taxes, to maintenance and repairs – it is in your best interest to understand the tax implications of second-home ownership.
Different tax rules apply depending on how you use the property, for either personal or rental use, or a combination of the two.
As long as you use the property as a second home – and not as a rental – you can deduct mortgage interest the same way you would for your primary home.
Rental Use – The 14-Day or 10% Rule
The tax rules are quite a bit more complicated if you rent out the property. Different rules apply, depending on how many days a year you use the home for personal versus rental use.
There are three categories into which you may fall:
- You rent out the property for 14 days or less.
- You rent out the property for 15 days or more, and use it for less than 14 days or 10% of days the home was rented.
- You use the property for more than 14 days or 10% of the total days the home was rented.
Selling Your Second Home
- The primary-home sale exclusion does not apply if you sell your second home: If you sell a house that is not your primary residence, you may have to pay the usual capital gains tax.
- If you make the second home your primary residence for at least two years before you sell it, however, you may be able to reap some tax benefits, but it’s not as easy as it used to be.
- Prior to Jan. 1, 2009, you could move into your second home, make it your primary residence for two years, sell it, and take advantage of the primary-home sale exclusion. Now, as a result of new laws associated with the Housing and Economic Recovery Act of 2008, you can still make your second home a primary home before you sell it, but you’ll owe taxes for the period of time that the property was a second home after Jan. 1, 2009.
- The IRS now uses a ratio of the years you occupied the home as a primary residence versus the years the home was used as a rental (or other-than primary residence) to calculate the amount of capital gain that will be excluded from the sale.
A 1031 exchange, also known as a like-kind exchange or tax-deferred exchange, is a transaction where a seller swaps a rental or investment property for another rental or investment property of equal or greater value, on a tax-deferred basis.
- The advantage is that the seller may be able to avoid paying capital gains tax on the exchange. A property must be considered a rental property (and not a personal residence) to qualify for a 1031 exchange.
- This means that you must rent out the property for 15 days or more, and use it for less than 14 days or 10% of days the home was rented.