Do you own a vacation home, rental property, a condo, or any other kind of second home? If you do, you probably have already realized your taxes are more complex than the average homeowner. Homeownership opens the door to some tax benefits or relief, but it also means more work. Luckily, second home tax breaks and deductions come in many forms, you just have to know how to spot and take advantage of them.
In some ways, a second home is taxed similarly to a first home or primary residence. However, the situation can become quite different depending on how you use the residence. Also, the tax situation can be more complicated when you sell your second home than it would be with your primary home.
For that reason, it’s important to know what you’re getting into beforehand. Talking with a tax professional before you buy could help you avoid surprises later. At Waters Hardy, we work with homeowners every day to ensure they understand their tax obligations as they relate to owning property. Tax planning and compliance are what we specialize in, and second home tax preparation services are within our expertise.
Personal Residence Mortgage Interest Deduction
If you use your second home property as just that, a second home, rather than renting it out, interest on the mortgage is deductible within the same limits as the interest on the mortgage on your first home.
- For tax years prior to 2018, you can write off 100% of the interest you pay on up to $1.1 million of debt secured by your first and second homes and used to acquire or improve the properties.
- For binding contracts or loans originated after December 16, 2017, the limit is reduced to $750,000 of debt secured by your first and second home.
- For loans prior to December 2017, the limit is $1 million ($1.1 million without the $100,000 home equity portion).
*Note: The $1 million mortgage interest limit will return in 2025 when the Tax Cuts and Jobs Act of 2017 (TCJA) expires, unless lawmakers act to keep the law in place.
Rental Property Mortgage Interest Deduction
If you rent out your second home for part of the year, even just for three weeks, the tax situation could become entirely different. Renting out a second home means that you’ll need to do a little bit more work with keeping track of expenses and income, but it may not necessarily make your tax bill higher. This is where the use of professional accounting services could assist with all of your tax prep needs.
Second Home Use Variations
- Use often, rent rarely
You don’t have to report rental income to the IRS if you rent your home for 14 days or fewer during the tax year. The house is considered a personal residence, so you can’t deduct rental-related expenses. However, you can deduct mortgage interest and property taxes as you would with any home. Also, when you sell the property, it will be treated as a personal residence, not an investment property.
- Use rarely, rent often
Because the home is considered a business, you can deduct rental expenses, including mortgage interest, property taxes, insurance costs, property manager fees, utilities, and property depreciation. However, you must report any income from the property as rental income, and that income will be taxed as ordinary income according to your tax bracket.
- Use some, rent some
This means you can deduct mortgage interest and property taxes as you would with any home, but it’s important to understand tax planning and compliance rules. For example, you can deduct rental expenses, but only up to the level of rental income.
Home Equity Loan Interest Deduction
You can deduct the interest you pay on a home equity loan or home equity line of credit (HELOC) only if you use the money to “buy, build, or substantially improve your home.” If you use the funds to pay for things like a vacation or college, you can’t deduct the interest.
Property Tax Deduction
Unlike the mortgage interest rule, you can deduct property taxes paid on any number of homes you own. However, as of 2018, the total of all state and local taxes deducted, including property taxes, is limited to $10,000 per tax return.
Selling Your Second Home
The IRS charges a capital gains tax when you sell an asset for more than you paid for it. This means that if your second house has appreciated in value, you’ll have to pay capital gains tax when you sell it.
Making the second home your primary home could potentially lessen the capital gains tax you pay. To do so, you would need to live in the second property for at least two years out of the five years before selling it. This would qualify the property as your primary residence. Also, to be eligible for the exclusion, you must not have taken the capital gains exclusion on the sale of another home during the previous two years.
Second Home Expense Taxes
Many second homeowners are opting to rent their homes, either “flipping” a property or renting out a second home as an Airbnb. While it’s an effective way to generate income, it creates more tax complexity. If your second home is considered an investment property, you can deduct expenses related to owning, maintaining, and operating the property, but this can get complicated. Having professional tax planning services in place can help alleviate this complication.
Owning a second home can be an excellent investment for vacation or rental purposes. Further, it could also provide a suitable primary home during retirement. Still, owning any home carries a significant financial burden, from mortgage and tax prep to maintenance and repairs. It’s in your best interest to take into consideration and learn the tax implications for a second homeownership.
Waters Hardy Can Assist You with Your Homeownership Needs
When you own a second home, the process of filing your taxes can be complex and confusing. The safest bet is to seek assistance from trusted tax professionals like the Waters Hardy team. We have the knowledge and experience to help you optimize your tax deduction with your homes.
Contact us today to speak with a tax professional for clarification or guidance on your property investments.
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