When it comes to buying residential real estate, there are three main categories a property can fall into for tax and mortgage purposes: principal residence, second home, or investment property.
You can generally only have one principal residence. This is the home where you spend most of your time, and there are some pretty unique tax benefits to a property classified as a principal residence. For example, you may be able to exclude some or all of your capital gains after selling a principal residence at a profit.
Beyond principal residences, there is certainly some grey area between second homes and investment properties. In this article, we'll take a look at why the distinction matters and whether you can classify more than one property as a second home.
What is a second home?
The exact definition of a second home depends on who you ask. The vague definition is that a second home is a property you live in some of the time while maintaining a principal residence somewhere else. Second homes are typically located in different cities than their owners' primary homes.
For tax purposes, the IRS considers a second home to be a property that you personally use for at least 14 days annually, or at least 10% of the days it's rented. For example, if your property rents for 180 days in a given year, you need to personally use it for at least 18 days in order to classify it as a second home for tax purposes.
On the other hand, your lender might have their own definition of a second home. Some won't originate second home loans for properties that will be rented at all, while others have looser requirements, such as the ability to rent as long as the owner doesn't hire a management company to book rentals.
Second homes vs. investment properties: Benefits and drawbacks
Second homes get somewhat different tax treatment than investment properties. It's not necessarily that one is better, but there are some key differences.
For one thing, second home mortgage interest can be tax-deductible. The current tax law states that the interest paid on as much as $750,000 of qualified personal residence debt can be deductible for those who choose to itemize deductions on their tax returns, and second homes qualify as long as they meet the IRS definition.
On the other hand, investment property owners can deduct their mortgage interest, but in a different way. They report their rental income on Schedule E, and interest can be considered an expense to help offset rental income.
With both classifications, owners are required to report their rental income on any property rented out for more than 14 days each year. For properties the owner uses personally, expenses related to the property must be divided proportionally between personal use and rental time.
Here's one of the biggest potential benefits to being able to classify a property as a second home: It's typically far easier to obtain mortgage financing on a second home than an investment property. There are similar credit qualification requirements as with a principal residence mortgage, and your interest rate will likely be similar. Your income will need to justify both mortgages, even if you plan to rent the property out some of the time.
On the other hand, lenders tend to have relatively strict requirements for financing investment properties, especially when it comes to credit history. Plus, you can expect to get an interest rate at least 0.5% to 1% greater than you would pay on a second home. However, you're typically allowed to use some of the expected income from an investment property to help qualify for the mortgage.
It's also worth noting that lenders typically only require that their definitions be met for a year (or other set time period). In other words, you can generally obtain a second home loan, use it as such for at least a year, and then treat it as a pure investment property after.
For a more in-depth discussion of the differences between second homes and investment properties, be sure to check out this guide.
Can you have more than one second home?
The short answer is yes. Despite the word "second" in the phrase, you may be able to consider a third, fourth, or fifth home as a "second home" for tax or financing purposes, as long as it meets the appropriate criteria.
One thing to keep in mind, however, is that it can be significantly more difficult to convince a lender that a third or fourth property is indeed a second home and not an investment property. You might need to produce a letter of explanation of why you need another second home (work purposes, family vacations, etc.), and the lender will want to see that all of your primary and secondary homes are sufficiently far away from each other. For example, it can be perfectly acceptable to have a primary residence in the suburbs, a second home at the beach, and another in the mountains.