The short answer
If I had to define the term "second home" in one sentence, I’d say that it’s a property that you plan to live in for part of the year, while simultaneously maintaining a primary residence elsewhere. However, that’s a very vague definition. Consider the following two scenarios:
- Your primary residence is a house in a suburban area and you buy a condo at the beach to use for three consecutive months each summer. The property is available for your personal use at all times and is never rented.
- You decide to buy a home in your favorite vacation destination. You use the home for two weeks each winter but rent it out on a weekly basis for the vast majority of the year.
Here’s the point. Both of these could be considered second homes, although they are used in completely different ways. It’s also important to realize that the word "second" can be misleading. It’s possible to have a primary home and several "second homes."
There are also narrower definitions of what constitutes a second home versus an investment property when it comes to obtaining financing, and these can vary from lender to lender. Plus, there are IRS definitions of these terms that can determine the tax implications of a property. With that in mind, let’s look at each of these individually.
Your lender might have their own definitions
While the definition I just gave of a second home is admittedly vague and has some gray area, mortgage lenders who originate "second home" loans generally have far more specific definitions. And these can vary dramatically from lender to lender.
Some lenders won’t make a second home loan if you plan to rent the property at all. Others are fine with making a second home loan if the property is rented, as long as the owner uses the property for a certain number of days each year.
Many lenders also have location requirements. Some want a second home to be a certain number of miles away from your primary residence, while others will only make second home loans in common vacation areas.
If a home doesn’t meet a particular lender’s definition of a second home, it will be considered an investment property.
Second home and investment property financing methods are different
Here’s why the financing issue is so important. It’s generally much easier to finance a second home than an investment property. You can typically find a second home mortgage with an interest rate that’s comparable to market rates for primary residences, credit qualifications are generally similar, and as long as your income justifies both mortgages, a second home loan is a pretty straightforward process in most cases.
On the other hand, investment property mortgages are typically more difficult to qualify for and are more expensive. Lenders often have higher credit score requirements when it comes to investment properties, and also generally charge higher origination fees.
Having said that, there are some advantages when it comes to qualifying for investment property financing. Unlike with a second home, you might be able to use some of your anticipated rental income to help you qualify for an investment property mortgage. In fact, you can find some lenders that aren’t even concerned with your other debts as long as the property is expected to generate enough cash flow to cover its expenses.
Second home vs investment property: The IRS definitions
As far as the IRS is concerned, you can consider a property to be a second home if it meets a certain owner-occupancy threshold. Specifically, if you use the home for at least 14 days each year or 10% of the days you rent it out, whichever is greater, it can be considered a second home for tax purposes. If it doesn’t meet the appropriate minimum, it is considered an investment property.
Technically, this is the IRS definition of a residence, not a second home, but it generally doesn’t come into play when it comes to anyone’s primary home.
Notice that the rule says that you "use" the home, not necessarily that you’re living there for any specific length of time. In other words, to meet the IRS’s 14-day minimum, it doesn't matter if you use it for seven two-day stays or two seven-day stays throughout the year.
Here’s an example: Let’s say that you rent your vacation home for a week at a time, and that it ends up renting for 40 weeks in 2018. This translates to 280 rented days, so if you personally use the home for at least 28 days, you can treat it as a second home. If you use the property for 27 days or fewer, it is officially an investment property in the eyes of the IRS.
Tax implications of second homes and investment properties
There is some overlap between the tax treatment of second homes and the treatment of investment properties. In both cases, rental income must be reported to the IRS, and the expenses involved with owning, repairing, and maintaining the property while it is rented can be deducted from the rental income. However, there are a couple big differences:
- Second homes are eligible for mortgage interest tax deduction, which is available to be used on the interest paid on up to $750,000 in qualified residential debt. Investment property owners can’t use the mortgage interest deduction in this way, but can deduct the interest paid on a mortgage as an expense against their rental income.
- Investment property owners, on the other hand, are eligible to claim an annual depreciation expense to further lower their taxable rental income. However, this results in a higher tax bill upon the property’s sale thanks to the depreciation recapture tax.
Regardless of how the property is classified by the IRS, if you use a home that you rent, you are required to divide your expenses between the time the property was used for rentals and the time you used it personally. In other words, if you had $5,000 in maintenance expenses for a property that was rented 50% of the days it was used, you can only claim $2,500 of that amount to offset your rental income.
It’s also worth mentioning that if you rent your second home for fewer than 15 days in a year, the IRS doesn’t require you to report any of your rental income. Even if you make thousands of dollars, the IRS isn’t concerned with your rental income unless your property is rented for more than two weeks.
The bottom line is that if you plan to use the home you’re buying for at least two weeks per year for your own occupancy, it can be considered a second home. However, there’s no set-in-stone definition, and there’s quite a bit of gray area. For example, your primary motivation for owning a property can be to generate rental income, but you might also plan to use the home personally for a few weeks each year, technically enabling second-home classification.
The distinction is important when it comes to financing and tax implications, so be sure that if you plan to use "second home" financing that you meet your lender’s definition of a second home. And be sure to check with a qualified tax professional who can tell you exactly how to treat your rental income and how to handle other tax considerations before you start your tax return.