Tax Breaks for Second-Home Owners

If you’re thinking about buying a second home to use for vacations, rental income, or an eventual retirement residence, it makes financial sense to take advantage of all available tax breaks on that property. The cost of owning another home can be greatly reduced through tax-saving deductions on mortgage interest, property taxes, and other expenses.

Tax changes stemming from the 2017 Tax Cuts and Jobs Act (TCJA), which is in effect until 2025, affect how much money you may be able to save. Starting with homes bought from Dec. 16, 2017, on, for example, homeowners are able to deduct interest on only up to $750,000 of qualified home loans, down from $1 million before the TCJA passed. (What's more, if you have an existing mortgage on your primary residence, this number will likely be reduced. See below for more information and check with your accountant or other tax advisor if this applies to you.

In addition, the interest on home equity loans can now be deducted only if the money was used for renovations to the property on which the loan was taken.

Still, even with these changes, there are useful tax breaks that can help make owning a second home more affordable. Here’s a quick rundown. 

Different tax rules apply depending on whether your second home is for personal use or whether you plan to rent it out. With rentals, the proportion of the year in which you rent the property—and live in it yourself—also comes into play.

Homes for Personal Use

The mortgage interest deduction has long been praised as a way to make homeownership more affordable. If you use a second property strictly as a personal residence and never rent it out, you're eligible to deduct mortgage interest in the same way you would on your primary home. To qualify for the deduction, the mortgage must be a secured debt on a qualified home that you own, and you must file IRS form 1040 and itemize your deductions.

Single filers and those married filing jointly can claim an itemized deduction for 100% of the interest they pay on their mortgage, up to a limit. Those limits vary according to when the mortgage originated. For tax years 2018 to 2025, the minimum limit is up to $750,000 of debt secured by your first and second homes – or $375,000 if you’re married and filing separately. However, if your mortgage existed before Dec.16, 2017, you’ll continue to receive the same, more generous tax treatment as under the old rules, with the interest on mortgages and any other loans deductible on up to $1 million in debt. 

Homes That Are Rented Out

The tax rules are quite a bit more complicated if you rent out the property for some or all of the year. Different rules apply depending on the proportion of time the home will be rented, rather than used personally. Your use of the property will fall into one of three categories:

1. You rent out the property for 14 days or less. You can rent your second home to other parties for up to two weeks (14 nights) within a year without having to report the resulting income to the IRS. The house is still considered a personal residence, and you can deduct mortgage interest and property taxes under the standard second-home rules.

This holds regardless of the rental rate; even the earnings from a home that rents for $10,000 a night, say, needn't be reported to the IRS, provided the property was rented for no more than 14 days throughout the year.

2. You rent out the property for more than 14 days, but stay in it fairly infrequently. The specific requirements here are that you use the home yourself for fewer than 14 days a year or 10% of the number of days the home was rented. If this applies—and the home is rented for more than 14 days a year—your home is considered a rental property and you must report its rental income to the IRS.
You can deduct rental expenses, including mortgage interest, property taxes, insurance premiums, fees paid to property managers, utility bills, and 50% of any depreciation on the property. You must, however, allocate these costs between the proportions of time the property was in personal and rental use during the year.

It’s worth noting that fix-up days don’t count as personal use, so you can spend more than 14 days at the property provided you’re doing maintenance for the additional time. Plan to document your maintenance activities by retaining receipts to prove you weren't just vacationing on those days.

3. You use the property for more than 14 days, and rent it infrequently.
To be specific, this scenario applies if you use the property yourself for at least two weeks a year or 10% of the total days in which the home was rented. If this is the case, the second home is considered a personal residence.
You can take the mortgage interest and property tax deductions, but you can’t claim rental losses. If a member of your family uses the property (including your spouse, siblings, parents, grandparents, children, and grandchildren), those days count as personal days unless you are collecting a fair rental price during those family stays.

For help in calculating your mortgage tax deduction, use an online worksheet, like this one from Bankrate, to determine how much money you may be able to save.

In addition to the mortgage interest deduction, you may be able to write off interest on a home-equity loan. However, the rules for such deductions changed beginning with the 2018 tax year.

Previously, you could take the deduction even if you used the home-equity loan to pay off credit card debt, take a vacation, or buy a second home. According to the IRS, you can now deduct the interest you pay on home-equity debt only if you use the money “to buy, build or substantially improve the taxpayer’s home that secures the loan.” To qualify, the loan must be secured by your primary or second home and it can’t exceed the cost of the home.

Those provisions mean that to claim an interest deduction for buying a second home, you’ll need to take out a mortgage for it; if you took out a home-equity loan against your primary home to make the purchase, you can't deduct the interest you paid on such a loan.

As of the 2018 tax year, you can deduct interest on $750,000 in home loans, including mortgages. However, keep in mind that this figure is the combined total of all loans used to buy, build, or improve your primary and second homes. If you already have $750,000 or more of mortgage debt on those residences, for example, you can’t claim a deduction for any home equity interest. 

You can deduct property taxes on your second home and, for that matter, as many properties as you own. However, here too, the 2018 tax year brought changes that affect those deductions..

You can no longer deduct the entire amount of property taxes you paid on real estate you owned. Now, the total of all state and local taxes eligible for deduction, including property and income taxes, is limited to $10,000 per tax return, or $5,000 if you're married and filing separately. Many people who buy a second home may already exceed that limit with their first home, and so may enjoy no additional tax savings for their second home. 

Tax laws allow you to take up to $500,000 profit (if you're married and filing jointly; $250,000, if you’re single) tax-free on the sale of your primary residence. This primary-home sale exclusion doesn’t apply if you sell your second home; such a sale may leave on the hook for capital gains tax on your entire profit.

Some moves may, however, allow you to avoid at least a part of the capital-gains hit for selling a second home. The first is to make the additional property your primary residence for at least two years before you sell it. That may allow you to take advantage of the tax break, provided that you meet the primary-residency requirements for tax purposes in your state. (You may also need to consider the tax implications for any rental income you may receive on your primary residence while you are living primarily in the second home.)

If your second home is mostly rented, or held as an investment, you might also consider swapping it for another comparable property. A 1031 exchange, also known as a like-kind exchange or tax-deferred exchange, allows you to trade 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 you may be able to avoid paying capital gains tax on the exchange.

To qualify for such a move, the property you're swapping must be considered a rental property, not a personal residence—which means you must rent out the property for at least 15 days and use it for less than 14 days or 10% of the days the home was rented each year.

If it's financially feasible, owning a second home can be an excellent investment for vacation or rental purposes, and could also provide a suitable primary home during retirement. But because owning any home carries a significant financial burden, from mortgage and taxes to maintenance and repairs, it’s in your best interest to learn the tax implications for you of second-home ownership. Since tax laws are complicated and change periodically, it’s advisable to consult with a qualified real-estate tax specialist who can explain relevant tax implications and laws and help you determine the most favorable ownership strategy for your situation.