A second home refers to a residential property that owners have in addition to their primary residence. The IRS distinguishes between primary homes, second homes, and investment properties based on how owners use the property.
For tax purposes, a second home must meet specific criteria:
It must be lived in for more than 14 days per year or 10% of the days it's rented out, whichever is greater
If rarely used personally, the property may be classified as an investment property
The property must have basic living accommodations, including a kitchen, bathroom, and sleeping areas
Types of Second Homes
Second homes come in various forms:
Vacation homes serve as getaways in desirable locations like beach communities, mountain towns, or lakeside retreats. These properties offer personal enjoyment and potential rental income.
Condominiums provide maintenance-free living with amenities like pools, fitness centers, and security. Condo owners typically pay homeowners' association (HOA) fees for these services.
City apartments function as convenient bases for work trips or urban experiences, often purchased in metropolitan centers far from primary suburban or rural residences.
Retirement homes act as future primary residences, purchased before retirement to secure favorable locations or financing terms.
Tax Benefits of Second Homes
Owning a second home offers several tax advantages:
1. Mortgage interest deductions allow homeowners to deduct interest paid on loans up to $750,000 across both primary and second homes (for mortgages taken after December 15, 2017). For mortgages before this date, the limit is $1 million.
2. Property tax deductions permit deducting property taxes paid, subject to the $10,000 cap on state and local tax (SALT) deductions. This cap applies to the combined total of property taxes paid on all properties, state income taxes, and local taxes.
Understanding available property tax exemptions can further reduce the tax burden. Many jurisdictions offer exemptions for various circumstances, such as homestead exemptions, senior citizen reductions, or disability qualifications. Each state and county maintains different rules for these exemptions.
3. Rental income benefits apply when owners rent their second home for 14 days or less per year, allowing this income to remain completely tax-free.
When renting for longer periods, owners must report the income but can deduct expenses like mortgage interest, property taxes, insurance, utilities, and maintenance proportional to rental days.
4. Capital gains exclusions become available if owners convert their second home to a primary residence for at least two of the five years before selling. This potentially allows owners to exclude up to $250,000 in gains ($500,000 for married couples) from capital gains taxes.
Tax Responsibilities and Considerations
Second home ownership also comes with important tax responsibilities:
1. Property tax assessments occur regularly, with many jurisdictions valuing properties annually. Second homes often face higher assessment rates than primary residences, making accurate valuations crucial. If owners believe their assessment is too high, they should consider filing property tax appeals to potentially reduce their tax bill.
2. Local tax regulations vary significantly. Some popular vacation destinations impose special taxes on second homes or short-term rentals to fund local services. These might include occupancy taxes, tourism improvement districts, or special assessment districts.
3. Rental income reporting becomes mandatory when renting property for more than 14 days annually. This requires detailed record-keeping of all rental income and expenses, typically filed with Schedule E of a tax return.
4. State residency implications arise because owning property in multiple states can trigger residency audits. Residents of multiple states might face tax obligations in each jurisdiction.
5. Insurance requirements often differ for second homes, particularly those used as rentals or left vacant for extended periods. Due to increased risks, insurers typically charge higher premiums for second homes.
Maximizing Tax Benefits
Owners of second homes should:
Keep meticulous records of all expenses related to the property, including improvement costs that can reduce capital gains taxes when selling.
Understand local tax laws in the second home's jurisdiction, as rules vary widely between locations.
Consider professional management if renting their property, as these expenses are typically tax-deductible.
Consult tax professionals familiar with second home regulations to ensure compliance and maximize available deductions.
Review property assessments annually, as challenging incorrect valuations through property tax appeals can yield significant savings.
Making the Most of a Second Home
A second home represents both a lifestyle enhancement and a significant financial asset. Successful owners understand and manage their tax situation effectively. Regular assessment reviews, knowledge of local regulations, and proper record-keeping form the foundation of smart second-home ownership.
Consulting with tax professionals specializing in single family investments and taxation can reveal additional savings opportunities, especially for properties in different states or those with complex usage patterns.
Owners shouldn't leave money on the table — they can review their property tax assessment today and explore potential property tax appeals or property tax exemptions to keep more of their second home investment working for them. Ownwell can help property owners start saving today.