Many people own two homes. Often, one is a primary residence and the other is a vacation home where the owners go to recharge their batteries. Second homes can be a house in the country, a cabin in the woods, a condo near the beach, a pied-à-terre in the heart of a city near theaters, museums and other cultural attractions or any other residence that is desirable to the owner. Second homes are also frequently investment properties or a place where a child in college can live, instead of the dorms. Or both.
Income tax and property tax implications, insurance coverage, maintenance and upkeep all play significant roles. But the first question you must ask yourself is, “Can I afford another home?” Should you borrow against your primary residence? That would mean convincing a lender that you are a good risk. Banks know that owners are more likely to default on second home mortgages, skip payments and go lightly on maintenance needs. It is not unusual for a lender to require a down payment of 20 to 40 percent for a mortgage on a second home.
Second home mortgages usually come at a higher interest rate. In order to get a mortgage with terms that are typical for a primary residence mortgage, you’ll have to convince (prove to) the underwriter that you plan to use the home as a primary residence. They may want to see you occupy the home within 30 days or for a certain number of days per year. A home is typically classified as a vacation home if it is at least 50 miles away from your primary residence. Anything closer might be classified as an investment property. Risks for lenders are greatest on investment properties (as compared with primary residences and vacation homes), so the rates are generally the highest.
Tax benefits of second homes
Tax savings from loss (up to $7,000 a year if you’re in the 28% percent bracket) help underwrite the expense of a vacation home. And when the house is considered a personal residence, you can deduct mortgage interest and property taxes under the standard rules for a second home.
If the second home is truly a “home” and not a rental, mortgage interest is deductible with the same limits as the interest on the mortgage on your first home. You can write off 100% percent of interest paid up to $1.1 million of debt secured by your first and second homes, and used to acquire or improve the properties. Note: That means a total of $1.1 million of debt, not $1.1 million on each home.
Property taxes on the second home are also deductible. Unlike the mortgage interest rule, you can deduct property taxes paid on any number of homes you own.
Renting out your second home
Second home buyers who rent the residence out for 14 days or less during the year can pocket the rental income tax-free. The rent amount is irrelevant, and the IRS does not require you to declare it if you do not surpass the 14-day limit.
Extended rentals have different rules. All income gained from renting for more than 14 days must be reported. Rental expenses are deductible but also tricky in that you need to distinguish between costs for the time the property is used for personal purposes, and the time it is rented. Calculate on the conservative side. This is not a venue for casual guesstimates.
If personal use is limited to 14 days the second home comes under the rental property rule and up to $25,000 in losses might be deductible each year. This explains why many second home homeowners hold down their private, exclusive leisure use in order to devote lots of time to maintaining the property. Fix-up days don’t count as personal use. The flip side is that holding down personal use means having to forget about the write-off for the portion of mortgage interest that does not qualify as either a rental or personal-residence expense.
Selling a second home
The rule that allows up to $500,000 of profit tax-free ($250,000 for a single person) applies only to the sale of the principal residence. A perfectly legal way around this is to make the second home your principal residence before you sell. When you live in the second home for two years, those $500,000 (or $250,000) of profit dollars can be tax-free. Any profit attributable to depreciation while you rented the place, though, would be taxable.
Buying a second home
If a second home is on your mind, the time has rarely been better. Interest rates are still low but rising. Prices continue to rise as well. In the year ending November 2013, home prices rose 14%, as measured by the S&P/Case-Shiller 20-city composite index. Some markets, such as Las Vegas, Los Angeles and San Francisco, saw prices rise by more than 20%. Plan to keep the second home for at least five years to break even. Short-term owner profits have not returned with the rising market.
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