If you’re thinking about buying a second home for vacations, rental income, or an eventual retirement residence, it makes financial sense to take advantage of all the available tax breaks. The cost of owning a second home can be significantly reduced through tax deductions on mortgage interest, property taxes, and rental expenses.

The Tax Cuts and Jobs Act (TCJA) changed how tax breaks work, such as lowering the mortgage interest deduction. Still, even with these changes, there are useful tax breaks that can help make owning a second home more affordable. Here’s a quick rundown. 

Key Takeaways

  • If you itemize deductions, the interest on your mortgage will likely be tax deductible up to a limit.
  • Different rules apply to the mortgage deduction depending on whether a second home is a personal residence or rental property.
  • You can deduct interest on home equity loans, but only if the funds are used for home improvements.
  • You can deduct property taxes on your second home, but there are limits.
  • The Tax Cuts and Jobs Act changed how many tax breaks work.

Mortgage Interest Deduction

The mortgage interest deduction has long been praised as a way to make owning a home more affordable. The TCJA, signed into law in December 2017, changed how much you can save via mortgage interest deductions for both a primary residence and a second home.

Single filers and those married filing jointly in most cases can deduct full interest on mortgages up to $750,000. This applies to any personal residence, be it your first or second. The previous limit was $1 million in mortgage debt, which still applies on home loans taken out before Dec. 16, 2017.

Different tax rules apply on the mortgage deduction depending on whether your second home is considered a personal residence or rental property. With rentals, the proportion of the year in which you rent the property—as opposed to living in it yourself—also comes into play.

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Tax Breaks For Second-Home Owners

Interest Deduction on a Personal Residence

If your second property is a personal residence, you're eligible to deduct mortgage interest in the same way as you would on your primary home—up to $750,000 if you are single or married filing jointly. The limit is $375,000 if you’re married and filing separately.

To qualify for the deduction, the mortgage must be a secured debt on a qualified home you own, and you must itemize your deductions by filing Schedule A. 

The $1 million mortgage interest limit will return in 2025, when the TCJA expires, unless lawmakers act to keep the law in place.

Interest Deduction on Homes Rented Out

The rules are complicated if you want to take tax deductions for rental property. What matters is whether you rent out the property for part or all of the year, and how often you use the property for personal use. Your use of the property will fall into one of three categories:

Property Rented Fewer Than 15 Days a Year

You can rent your home for fewer than 15 days during the tax year without having to report the income to the IRS. The house is considered a personal residence, which means you cannot take deductions for rental expenses. But you can deduct mortgage interest and property taxes as you would with any home.

This special rule applies even if you rent your home for $10,000 per night. Section 280A(g) of the Internal Revenue Code says the money doesn't need to be included in your gross income, provided the home was rented for fewer than 15 days per year.

Property Rented 14 or More Days a Year and You Seldom Use It

Your home is considered a rental property—and not a personal residence—if it is rented for 14 or more days per year, and if your own personal use of the property does not exceed 14 days per year, or 10% of the number of days the home was rented.

If you meet this requirement, then income from the property is reported as rental income. You can also deduct rental expenses, including mortgage interest, property taxes, insurance costs, fees paid to property managers, utilities, and depreciation of the property. However, you must apportion these costs between your personal use of the property and the time it was rented.

It’s worth noting that days spent fix upping the property do not count as personal use. It is possible to exceed the 14-day limit if you stayed at your property to perform maintenance. Plan to document your maintenance activities by retaining receipts to prove you weren't just vacationing on those days.

You Use Property More Than 14 Days and Seldom Rent It

If you stay at the property for more than 14 days per year, or more than 10% of the total days in which the property was rented, then the second home is considered a personal residence. This means you can deduct mortgage interest and property taxes as you would with any home, but you cannot claim rental losses. If a member of your family uses the property (including your spouse, siblings, parents, grandparents, children, and grandchildren), those days count as personal days unless you are collecting a fair rental price during those family stays.

Home Equity Loan Interest Deduction

In addition to the mortgage interest deduction, you may be able to write off interest on a home equity loan. However, the TCJA has changed these rules as well.

Previously, you could borrow against home equity and take a deduction on the interest regardless of whether the proceeds were used to pay off a credit card, take a vacation, or buy a second home. Now, you can deduct interest on home equity debt only if the funds were used “to buy, build, or substantially improve the taxpayer’s home that secures the loan.” In addition, as under the old rules, the loan must be secured by your primary or second home, and can’t exceed the cost of the home.

Under these provisions, if you want to deduct interest on a second home, you must have a mortgage on it. If you borrowed against equity on your first home to finance the purchase of your second home, this interest cannot be deducted. Like a mortgage, you can deduct interest on up to $750,000 in home equity debt if you are single or married filing jointly ($375,000 if married filing separately).

The limit applies to all your mortgage and home equity debt. If you already have $750,000 or more in mortgage debt, you wouldn't be able to claim an interest deduction on home equity loans exceeding that amount.

Property Tax Deduction

You can deduct property taxes on your second home and, for that matter, as many properties as you own. However, here too, the TCJA has brought changes that affect those deductions.

You can no longer deduct the entire amount of property taxes you paid on real estate you own. Now, the total of state and local taxes eligible for a deduction—including property and income taxes—is limited to $10,000 per tax return, or $5,000 if you're married and filing separately. Many people who buy a second home may already exceed that limit with their first home, and so will not see additional tax savings from their second home. 

Selling Your Second Home

If you sell your primary residence, the law allows single taxpayers to exclude up to $250,000 in capital gains from your income. Couples who are married and filing jointly can exclude up to $500,000 in capital gains. However, this is for sales of primary residences only. When you sell your second home, you must pay a capital gains tax on your entire profit. 

By making your second home your primary home, you could potentially lessen the capital gains hit. First, you would need to live in the second property for at least two years out of the five years prior to selling it. This would qualify the property as your primary residence. Also, to be eligible for the exclusion, you cannot have taken the capital gains exclusion on the sale of another home during the two-year period prior to the sale of this new primary residence.

1031 Exchanges

If your second property is held for business or investment, you might be able to defer capital gains taxes under a 1031 exchange. Known as a like-kind exchange, this involves selling the property and replacing it with a similar property. Once you have sold the initial property, you must identify its replacement property within 45 days and acquire it within 180 days. Capital gains are then deferred until the replacement property is sold (though it is possible to continually defer taxes with further like-kind exchanges).

Several conditions must be met to qualify for a like-kind exchange. The taxpayer must have owned the property for at least two years prior to selling. In each of the two 12-month periods prior to the sale, the taxpayer must have rented the property for at least 14 days. Furthermore, the taxpayer's personal use of the property cannot exceed 14 days per year, or 10% of the days the home was rented.

Finally, the replacement property must also meet these same conditions: it must be held for at least two years after the like-kind exchange; rented for at least 14 days per year; and cannot be used for personal enjoyment for more than 14 days per year, or 10% of the days the home was rented.

Since tax laws are complicated and change periodically, it’s advisable to consult with a qualified real estate tax specialist who can explain relevant tax implications and laws and help you determine the most favorable ownership strategy for your situation.

The Bottom Line

If it's financially feasible, owning a second home can be an excellent investment for vacation or rental purposes, and could also provide a suitable primary home during retirement. But because owning any home carries a significant financial burden, from mortgage and taxes to maintenance and repairs, it’s in your best interest to learn the tax implications for you of second-home ownership.