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- If you’re considering buying a second home, there are a few pros and cons to weigh when it comes to your taxes.
- Homeowners can deduct up to $10,000 total of property taxes per year on federal income taxes, including taxes on a second home.
- If you don’t rent out your second home, it’s taxed much like a primary residence, with mortgage interest and property taxes deductible.
- If you’re planning to rent out your second home for part of the year for income, however, your taxes will be much different, with more deductions available, and income tax due on any rental income.
- Policygenius can help you compare homeowner’s insurance policies to find the right coverage for you, at the right price »
Owning a second home has never sounded so good. If you think you’re ready for the financial part of buying a second home, there’s one other piece of the financial puzzle to consider: taxes.
In some ways, a second home is taxed similarly to a first home or primary residence. But, the situation can become quite different depending on how you use the residence. And the tax situation can be more complicated when you sell your second home than it would be with your primary home.
For that reason, it’s important to know what you’re getting into beforehand. Talking with a tax professional before you buy could help you avoid surprises later, and understand what it means for your budget.
But, there are a few general things to consider before setting out on your search. Tax expert and CPA Lisa Greene-Lewis of TurboTax says that there are four main tax implications to consider before buying a second home.
Owning two homes means paying two sets of property taxes — but it may not all be deductible
It sounds obvious — when you own two homes, you pay property taxes twice. But, you may not be able to deduct those property taxes on your second home, depending on how much property tax you already pay.
Both sets of property taxes are eligible to be deducted on federal income taxes. And, up until 2017, there was no cap on how much property tax homeowners could deduct. But the Tax Cuts and Jobs Act of 2017 established a limit, and owning a second home may mean passing that limit if you pay a lot of property tax on your first home.
“Under tax reform, the total amount of property taxes that you can deduct is $10,000 [per year],” says Greene-Lewis.
Property taxes vary greatly by state. While Alabama has a state property tax rate of 0.42%, New Jersey has a 2.44% property tax rate. The amount of property taxes you’ll pay also varies based on the value of the home. Given that, the $10,000 deductible limit is reached faster in some parts of the country than in others.
If you pay $10,000 or more in property taxes on your first home, you likely won’t be able to deduct any of the property taxes from your second home. Before buying, it might be worth looking at your current tax bill to see if you’d qualify for the deduction, and remember that property taxes tend to rise over the years.
If you’re the only one using your second home, your taxes won’t be as complicated
If you’re not planning to rent your second home to others, there are a few benefits — aside from having the place all to yourself. A second home not used for income is treated very similarly to a first home for tax purposes, and that could make things easier at tax time.
“You would be able to deduct the same expenses as your primary home. That would be your mortgage interest and property taxes,” Greene-Lewis says.
This also goes for anyone who rents out their home sporadically for a few days each year. “If you rent it out for fewer than 14 days, it’s still considered a personal property,” she says.
If you’re planning to keep the second home as a personal residence, your taxes won’t change much, especially if you’re still able to deduct the property taxes.
Taxes are different if you’re renting your property, even for part of the year
If you rent out your second home for part of the year — even just for three weeks — the tax situation could become entirely different.
“If you’ve rented it out more than the 14 days, it could be considered a rental property,” Greene-Lewis says. That includes renting the home short-term on vacation rental platforms. And while that does mean paying taxes on any income you bring in from your home, it also opens up the possibility of deductions.
“You are able to deduct a lot more on your rental property,” Greene-Lewis says. “You still get to deduct the mortgage interest and property taxes, but you can also deduct utilities, maintenance, and anything you do to fix up the property.”
These deductions can add up, and offset the amount you could owe on the rental income. “If you had to put a new roof on, that’s deductible. With your personal residence, you can’t make those types of deductions,” she says.
Renting out a second home means that you’ll need to do a little bit more work with keeping track of expenses and income, but it may not necessarily make your tax bill higher.
Consider what will happen when you sell the property
While second homes get many of the same tax breaks as first homes, there could be a big difference in how the property is taxed if you ever decide to sell.
“When you sell your personal residence, you can exclude a gain of $250,000 on the sale if you’re single, or $500,000, if you’re married, filing jointly,” she says. But the same isn’t true for second properties — those are considered investments, and taxed at capital gains tax rates, which can be high.
Long-term capital gains tax in 2020 ranges from 0% to 20% depending on income, and can be higher if you owned the property for less than a year.
However, there is a way around this: move into the property. “If you’re considering selling a second property, as long as you live there for two of the five years before the sale, it is considered a personal residence,” Greene-Lewis says. “Then, you could get that capital gains exclusion.”