So you have decided that you are interested in buying a second home. One of the important factors you are probably considering is the financial ramifications of buying a second home. And one of the important financial considerations is the tax consequences of buying and owning a second home. Your accountant or tax advisor should be a key part of your home-buying process. Here are some tips to discuss with your advisor:


Personal Use Deductions

If you only use your property for personal purposes and do not rent it out, you can take allowable expenses as itemized deductions on Schedule A. These expenses include the amount of mortgage interest you pay (for your first and second homes), real estate taxes, and casualty and theft losses. For more information, talk to your accountant, and check out IRS Publications 936, Home Mortgage Interest Deduction. If you rent out your home for more than a minimal amount of time, your second home may be treated as an investment property.

Should You Rent Your Second Home

Generally speaking, if you rent out your second home for less than 14 days a year, you do not have to report any rental income, and you can still deduct your mortgage interest and real estate taxes. If you rent it out for more than 14 days, you will need to report the income, and deduct expenses associated with renting on your Schedule E, Supplemental Income and Loss. The Schedule E categories for deduction include advertising, cleaning, maintenance, insurance, management fees, repairs, mortgage interest, taxes, utilities, and depreciation. In general, if you use your second home for both rental and personal use, you prorate the expenses accordingly. You will want to keep very accurate records for your property, and always work with your accountant. Also, check out the IRS Publication 527, Residential Rental Property.

Limits on Deductions

Generally, the amount of rental expenses deductible is limited to the amount of rental income. If, for example, the mortgage interest, real estate taxes, casualty and theft losses, and rental activity expenses (such as rental agency fees, advertising, etc.) create a rental loss, then other expenses such as depreciation, operating expenses (i.e., repairs, utilities, pest control) would no longer be deductible. There may also be limitations on your deductions depending on your gross taxable income from all sources. You will want to check with your accountant for an exact description of the effects a second home might have on your taxable income.

Selling Your Second Home

If you sell your second home, you will ultimately report capital gain or loss on Schedule D, Capital Gains and Losses. The basis of the property is reduced by the amount of depreciation you claimed previously (if used as a rental property). The rates on capital gains have been changing as of late, so consult your tax advisor. Another planning technique to consider is that if you sell your primary residence, and take your $250,000 (or up to $500,000) capital gains exclusion, and then move into your vacation home (and live there for 2 out of the last 5 years before selling it), you may be able to sell your vacation home and take another $250,000 to $500,000 in capital gains without paying tax. For more information, check out IRS Publication 523, Selling your home.


*Tax regulations and laws change on a regular basis. Before buying or selling real property, be sure to obtain advise from your own tax or legal advisors for the most current laws and regulations.