How To: Second Home Tax Deductions

Picture this: escaping from the city in the midst of a blistering summer to your blissful second home by the lake. If you have a second home or are thinking about buying a home, it makes sense to take advantage of the tax deductions available to you as a second-home owner. Be it for use as a rental, a vacation home, or an eventual retirement residence, you can get the most out of your second home. You can also reduce costs through tax deductions on mortgage interests, property taxes, and rental expenses. 

Your Property and Your Taxes

Did you know that the way you use your property will affect how you do your taxes? It could even affect what type of deductions are available!  For example, a house that is primarily used as a rental differs from one that is used for personal vacations. And if your house is intended for both uses, you will have to factor in how much time is allocated to each one. It is also important to consider the recent Tax Cuts and Jobs Act (TCJA), which lowered the interest rate deduction limit and set new parameters for deducing based on home equity interest.

Mortgage Interest Deduction

If your second home is for personal use, you may be able to obtain a mortgage interest deduction the same way you would on your primary home. The TCJA now allows those who itemize their deductions to exclude interest on mortgages of up to $750,000 if you file on your own or together with a spouse, or $375,000 if you file separately. 

To qualify, the mortgage must be a secured debt on a qualified home you own and you should file a Schedule A form to itemize your deductions. If you took out your mortgage before December 16, 2017, the old tax rules still apply, meaning you can deduct up to 100 percent mortgage interest on up to $1 million in debt, or $500,000 if you file separately. 

If the property is instead primarily used as a rental, you must consider how much of the year you rent it out and how much you use it on a personal basis. If you rent it for fewer than 15 days per year, you don’t have to report this income to the IRS as the house is still considered a personal residence. If you rent it at a fair market price for more days and personally use it for less than 14 days per year (or 10% of the number of days it was rented) it is considered a rental. 

Reporting Income From Renting A Second Home

Income from properties considered rentals must be reported as rental income. That said, you can still itemize and get deductions from rental expenses, including mortgage interest, property taxes, insurance costs, utilities, maintenance, and depreciation of the property. These costs must be evaluated considering personal use of the home and the time it was rented. 

Your second home can be both a rental and a residence if you rent it for 15 days or more in the tax year and also use it as a residence. If this is the case you also have to report the rental income and can’t deduct expenses attributed to the rental, but can deduct your interest and taxes if you itemize your deductions. 

You will have to divide the costs between the times it is used as personal or as a rental when filing taxes. It is a residence if you or a family member uses the home for more than 14 days or 10% of the number of days you rent the home. Maintenance time does not count as personal use so keep your receipts to prove you weren’t there. 

Home-equity Interest Deduction

You may be able to write off interest on a home equity loan. Previously, you could deduct interest regardless of how the money was spent. However, TCJA has changed the rules, and interest can only be deducted if the money was used “to buy, build, or substantially improve the taxpayer’s home that secures the loan.” The loan must also be bound by your primary or second home and can’t exceed its cost. 

So, you must have a mortgage for your second home if you want to deduct interest on it. The deduction limit of $750,000 if married filing jointly (and $375,000 if filing separately) applies to all mortgage and home equity debt. This means you can’t claim a deduction on home equity that exceeds that amount if you already have some in mortgage debt.

Property Tax Deduction

Here’s the good news: property taxes can also be deducted on as many properties as you own. The TCJA limits, however, the total of state and local taxes eligible for deduction at $10,000 per tax return, or $5,000 if married filing separately. You may not enjoy additional tax breaks if you already exceed this limit with your first home.  

What Happens If I Want to Sell?

If you are looking into selling your second home, be prepared to pay a capital gains tax on the complete profit. This is charged by the IRS when you sell an asset for more than what you originally paid for it. If you rent out your second home for profit, you can deduct the loss and this is taxed at a minimum rate of 28%. The sale must be treated as a part business, part personal if the home was used for both personal use and rental. 

You could potentially reduce the hit if you make your second home, your primary one, for at least two years in the five years prior to the sale. This qualifies it as your primary residence, but you also cannot have taken the capital gains exclusion on the sale of another home in the two years before the sale of the property in question.

You can exclude up to $250,000 if you are single-filing and $500,000 if filing jointly. If you do not meet the two-year ownership requirement, you are only legally entitled to the exclusion if you sell the property because of a change in health, in place of employment, or an unforeseen circumstance. 

Home Sweet Second Home

Owning a second home is a meaningful investment! The costs involved mean it is best to be advised on the potential implications that come along with it, particularly as tax laws are complex and change regularly. A financial advisor can help you make sense of how a second home might fall into your financial plan and navigate the best strategy for your situation.