If you ask a real estate agent, a mortgage lender, and a tax attorney to define a second home, you'll probably get three different answers.
There's no specific definition of a second home, other than a property that isn't your primary home that you live in some of the time. But when it comes to the actual number of days you occupy the property and whether you rent it out when you aren't using it, there's no set-in-stone definition.
The IRS has a clear distinction between second homes and investment properties, and it's important to know it when you do your taxes. Here's how to tell how the IRS categorizes your property and the tax differences that come with it.
Second home vs. investment property: What's the difference?
The simple answer is that a second home is a property other than your primary home that you intend to live in some of the time. An investment property is a home that you'll never live in.
It's important to clarify that the term "second home" is somewhat misleading. You can have more than one home that's considered a second home as long as it meets the appropriate definition.
Having said that, the precise definition of a second home depends on who you ask.
How lenders define a second home
Lenders tend to have their own rules on which purchases qualify for second home financing. Some let you rent the property for a certain amount of time, while others won't finance a second home if you plan to rent it at all.
Generally speaking, it's easier and cheaper to finance a second home than an investment property. So lenders take steps to ensure that the property in question is actually going to be someone's second home -- not just an investment.
How the IRS defines a second home
The IRS has its own definition of a second home, and it's important for tax purposes. You can consider a property a second home if you meet one of two conditions:
- You use the home at least 14 days each year.
- You use the home at least 10% of the days that you rent it out.
It's important to note that you have to satisfy the condition that results in the greater number of days.
For example, if you rent your property out for 200 days in a year, you need to personally use it for at least 20 days for it to be considered a second home. If you use it less than that, it's an investment property for tax purposes.
This doesn't mean you need to use it for any consecutive number of days. In our example, you can meet the 20-day requirement with four five-day stays, two 10-day stays, or any other combination.
Technically speaking, this is how the IRS defines any residence. But it generally doesn't come into play with primary residences.
Second homes get the mortgage interest deduction
It’s well-known that mortgage interest is deductible on primary residences if you itemize deductions. However, many people don’t realize that the mortgage interest deduction can apply to second homes, as well.
The IRS currently lets you deduct the interest paid on as much as $750,000 in qualified personal residence debt. This can mean a primary residence or a secondary residence. It could also apply to home equity debt if the money you borrowed was used to substantially improve a primary or secondary home.
This deduction isn't available for investment property mortgage interest. It can be deducted as a business expense to lower your rental income, however.
One caveat is that the mortgage interest deduction is an itemized tax deduction. You can’t use it if you claim the standard deduction.
For the 2019 tax year, the standard deduction is $12,200 for single taxpayers and $24,400 for married taxpayers filing joint returns. Unless your itemizable deductions, including mortgage interest, are greater than your corresponding standard deduction, you won’t benefit from deducting mortgage interest on a second home.
Rental properties get a depreciation deduction
Investment properties never qualify for the mortgage interest deduction. However, there's another tax benefit known as depreciation that investment property owners can take advantage of. A few second-home owners can use it, too.
Here's how it works. When a business buys an asset that has a finite useful life span, that business can deduct the cost of the asset over a certain number of years. For example, a $1,000 asset with a useful life of five years could be deducted at the rate of $200 per year until the entire amount had been written off.
This also applies when businesses buy real estate. The IRS lets investors depreciate the cost of their investment properties over a period of 27.5 years (39 for commercial properties). If you buy an investment property for $200,000, you'll get a $7,273 annual depreciation deduction. You can use this to offset your rental income.
This can result in big tax savings, but there's a caveat. If you sell your investment property, you'll have to pay a tax known as depreciation recapture. In short, all the depreciation deductions you've taken are considered taxable income when you sell. Investors can avoid this by using a 1031 exchange to buy another property, but you may have to repay your depreciation deductions eventually.
The depreciation deduction can apply to second homes as well, but only for the proportion of the days the property was used as a rental. For example, if you rent your home for 70 days this year and use it for 30 days, you can only take 70% of a normal full-year depreciation deduction. The same depreciation recapture tax applies when you eventually sell the home.