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Owning a second home can be a great way to enjoy vacations and build long-term financial stability. However, second homes don’t offer the same tax benefits as primary residences. Without careful planning, your second home can turn into a costly tax headache.
Understanding how property taxes, mortgage interest limits, rental regulations, and capital gains taxes can impact your tax bill can help you lower your tax liability and hang on to more of the wealth you’re building.
Key Takeaways
- The Tax Cuts and Jobs Act (TCJA) impacts property tax and mortgage interest deductions for second homes.
- Converting a second home to a primary residence can offer capital gains tax exclusions.
- Renting out a second home may provide tax benefits but also involves income tax considerations.
- Various tax credits and deductions can help reduce tax liabilities on a second home.
- Consulting with a tax professional is crucial for personalized tax strategies and compliance.
Understanding Tax Implications for Second Homes
The Tax Cuts and Jobs Act (TCJA), signed into law in January 2018, was the biggest tax overhaul the US has seen in over thirty years. In addition to adjusting tax rates for individuals and creating a flat corporate tax, the TCJA also capped some tax benefits for homeowners.
Congress must vote to extend the TCJA before it expires on December 31, 2025. If Congress does not extend it, tax provisions will return to pre-TCJA levels.
Property Taxes
The State and Local Taxes (SALT) deduction allows taxpayers to deduct certain taxes paid at the state and local levels on their federal return. Common examples of SALT include real property taxes, personal property taxes, state income taxes, and sales taxes.
Before TCJA, there was no cap on the amount of SALT deductions taxpayers could claim. However, under TCJA, the SALT deduction is now capped at $10,000 total across all sources.
If your combined SALT deductions, such as state income taxes and property taxes, have already hit the $10,000 cap, you cannot deduct property taxes from your second home beyond that amount. However, if your deductions are still under the $10,000 limit, you can include property taxes from your second home up to the threshold.
Mortgage Interest Deductions
The TCJA also changed mortgage interest deductions for homes purchased after December 15, 2017. Pre-TCJA, you could deduct combined mortgage interest up to a cool $1,000,000 for joint filers and $500,000 for single filers.
For homes purchased before December 15, 2017, this limit still applies. If you bought your homes after December 15, 2017, your new deduction cap is $750,000 for married filing jointly or $375,000 for single filers.
If you bought both homes around the December 15, 2017 cutoff, the mortgage interest deduction for your first home can be up to $1,000,000, but the second home is limited to $750,000. However, the combined mortgage interest deduction for both properties cannot exceed $1,000,000.
Capital Gains Tax
When you sell a second home, any profit is subject to capital gains tax. Your capital gains tax rate depends on how long you owned your home and your taxable income.
Short-term rates are the same as your ordinary tax rate (10%-37%) and apply to homes you’ve owned for less than one year. Long-term capital gains rates are 0%, 15%, or 20%, depending on your taxable income.
You could save thousands by timing the sale of your second home to ensure you’ve owned it for at least one year.
Strategies to Minimize Taxes on a Second Home
Convert Your Second Home to Your Primary Residence
Changing your second home to a primary residence can help you avoid or reduce capital gains tax when selling. To qualify for capital gains exclusions, you must meet certain conditions, such as living in the home for at least two of the last five years before the sale. To make the switch, you must change your official mailing address with the post office, register to vote using your updated address, and use the home most of the year for two of the last five years.
Switching your home from a secondary to a primary residence requires some preplanning. Still, it can save big on taxes since profits from primary home sales are excluded from capital gains taxes up to $500,000 for joint filers and $250,000 for single filers.
Consider Renting Your Second Home
If you rent out your second home for less than 14 days per year, any income from the rental is tax-free, and you can deduct property taxes and mortgage interest under a personal itemized deduction.
If you rent your second home for more than 14 days per year, you must report the money you make from the rental, but you can still deduct your mortgage interest and property taxes—this time as business expenses. Business expenses are not subject to the same TCJA caps, and rental properties qualify for additional deductions like maintenance and utilities expenses and depreciation.
| 14-Day Rental Rules | |||
|---|---|---|---|
| Personal Residence | Rental Property | Personal Residence | |
| Rental Status | Rental days ≤ 14 | Rental days > 14, personal days ≤ 14 | Personal days > 14 or 10% of rental days |
| Income Tax on Rental Revenue? | No | Yes | Yes |
| Rental Expense Deductions? | No | Yes | Yes |
| Tax Forms | Schedule A | Schedule E or C | Schedule A, E, or C |
Utilize Tax Credits and Deductions
In addition to mortgage interest and property tax deductions, you may qualify for other tax credits or deductions. For example, energy-efficient upgrades, home improvements (for rental properties), and insurance costs might make you eligible for additional deductions. You must keep detailed records of your expenses and consult IRS guidelines to ensure eligibility.
Consult With a Tax Professional
Tax rules are complex and updated frequently, especially as the TCJA cuts are expected to expire at the end of 2025. Consult a tax advisor to help you strategize a way to maximize tax savings for your specific situation while ensuring you comply with local, state, and federal laws.
Can You Deduct Mortgage Interest on a Second Home Outside the U.S.?
Mortgage interest on a qualified second home outside the US may be deductible based on specific IRS qualifications.
Are There Tax Benefits to Renting Out My Second Home?
Whether you rent your second home out full-time or just a few days a year, there are tax benefits. If you rent it out for less than 14 days per year, you can deduct mortgage interest and property taxes as personal deductions (to the caps established by TCJA). If you rent your home for more than 14 days, you have to report your rental income, but then your expenses like mortgage interest, property taxes, maintenance, utilities, and depreciation may all be deducted on a Schedule E.
Can You Avoid Capital Gains Tax by Buying Another House?
Homeowners can avoid paying capital gains on the sale of a home through a 1031 exchange. This exchange allows taxpayers to sell one house and reinvest the profits into a similar property. The tax requirement in these instances is deferred until the sale of the 1031 exchanged property.
How Can Changes in Tax Laws Impact Second Homeownership in the Future?
Before the TCJA, homeowners enjoyed more generous tax breaks, with higher limits on mortgage interest and SALT deductions. If the TCJA expires, these larger deductions could return. However, future tax legislation could tighten the rules further, reducing the tax benefits homeowners can claim now.
The Bottom Line
Owning a second home can be a rewarding investment, both financially and personally. However, the tax responsibilities of second homes can eat away at your investment over time.
The good news is that several strategies can help you minimize your tax bill and maximize available deductions. Whether you rent out your second home to claim business expenses or take advantage of mortgage interest and property tax deductions, understanding the IRS rules and how to use them can help you keep more of your hard-earned money.
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