Buying a second home can be significantly easier and less costly to finance than buying an investment property. Investment properties can offer you tax deductions by claiming operating expenses and ownership. Second homes, on the other hand, can also generate rental income and tax deductions for expenses, as long as the owner lives there for at least 14 days a year or 10% of the total days rented. Let’s break down the differences.
A financial advisor could help you put a financial plan together for buying a second home or an investment property.
What Is a Second Home?
In addition to a primary residence, homeowners may have a second home. This property can be a vacation home or a residence that you can use for work. Essentially, a second home is defined as a place where you would only live for part of the year.
The IRS defines a second home as a place that you visit for at least 14 days during the tax year. Aprimary residence, by contrast, is where the owner lives most of the year.
It’s possible to have more that one second home. And, you can also generate income by renting a second home to third parties for part of the year. The property will meet the definition of a second home, rather than an investment property, as long as the owner lives there for a number of days equal to at least 10% of the days the home is rented or 15 days a year.
What Is an Investment Property?
Unlike second homes, investment properties can be more than one unit. Investors commonly buy them with the intent of making money from rental income. Some investors also buy investment properties with the goal of flipping them in to sale for profit. And depending on the zoning of the property, investment properties can also be rented as commercial spaces.
Investment properties don’t have any occupancy requirement. They can be rented out 365 days a year to third parties. Rentals may be long-term, such as on an annual lease basis or short-term. Owners make money on investment properties from rental income, appreciation and tax deductions they can use to shelter income.
Financing Second Homes and Investment Properties
When applying for a mortgage, a borrower has to indicate whether the property will be used as a primary residence, second home or investment property. Primary residences are the easiest and least expensive to finance, with looser qualification standards and lower interest rates. Down payments on primary residences may be as low as 3% of purchase price on conventional loans, 3.5% on FHA loans and zero on VA loans.
Lending requirements on second homes are stricter. Lenders are likely to look for a lower debt-to-income ratio to be sure the buyer can cover the second mortgage payment, for instance. Second-home mortgages may require 10% down. Interest rates are also likely to be slightly higher than primary home mortgages. Except for a few special circ*mstances, FHA loans can’t be used to purchase second homes.
Investment property is the hardest to finance. Lenders call for down payments of 25% or so and also prefer higher credit scores. Government-backed lending programs generally can’t be used to buy investment property. Financing an investment home is likely to involve paying more interest and additional fees to the lender. However, borrowers can often use the projected rental income to help them qualify for an investment mortgage.
Taxes on Second Homes and Investment Property
Like primary residences, second homes with a mortgage can provide the owner with a tax deduction for the interest on the loan. Owners of second homes who rent them out part of the time may be able to reduce the amount of taxable rental income by deducting expenses for owning the home. To qualify for these deductions, the property must be rented at fair market value for more than 14 days or at least 10% of the total days rented per year.
Investment homes also offer a host of tax deduction opportunities. Owners can claim expenditures for mortgage interest, property taxes, insurance, maintenance, utilities and losses due to damage. They can also deduct a percentage of the property’s value each year due to depreciation.
Bottom Line
Second homes and investment homes are looked at differently by lenders and taxing authorities. Second homes are harder and more costly to finance than primary residences. Loans for investment homes generally involve more costs and are harder to qualify for. Second homes can offer some tax breaks, as well as the opportunity to generate part-time rental income. Expenses related to owning an investment home can help shelter rental income from taxes.
Tools for Buying Real Estate
- Whether you’re buying a second home or an investment property, a financial advisor could help you create a financial plan for your needs.SmartAsset’s free tool matches you with up to three vetted financial advisorswho serve your area, and you can have free introductory calls with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- If you don’t know how much money you’ll need to buy a home, SmartAsset’s free calculator could help you figure out how much home you could afford.
- SmartAsset’s mortgage calculator let’s you estimate your monthly mortgage payment with taxes, fees and insurance.
- Use our mortgage comparison tool to compare mortgage rates from top lenders and find the one that best suits your needs.
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FAQs
Investment properties can offer you tax deductions by claiming operating expenses and ownership. Second homes, on the other hand, can also generate rental income and tax deductions for expenses, as long as the owner lives there for at least 14 days a year or 10% of the total days rented.
What is the difference between 2nd home and investment property? ›
Second home: A second home is like a vacation home — one you purchase for enjoyment purposes and live in or visit during part of the year. It is separate from your primary residence. Investment property: An investment property is one you plan to rent out with the goal of generating income.
Is a second home considered investment property by IRS? ›
Assuming your second home is considered a rental/investment property: You must report rental income to the IRS if you rent your home for more than 15 days per year and your personal use of the property does not exceed 14 days per year or 10% of the number of days that the home was rented.
What is the 2 rule for investment properties? ›
What Is the 2% Rule in Real Estate? The 2% rule is a rule of thumb that determines how much rental income a property should theoretically be able to generate. Following the 2% rule, an investor can expect to realize a positive cash flow from a rental property if the monthly rent is at least 2% of the purchase price.
What is the IRS definition of investment property? ›
The definition of an "investment property" is a property that's: not your primary residence, and. is purchased or used to generate income, profit from appreciation, or take advantage of certain tax benefits.
What does the IRS consider a second home? ›
A property is viewed as a second home by the IRS if you visit for at least 14 days per year or use the home at least 10% of the days that you rent it out. Many homeowners rent out their second home, but personal and rental use affects taxes in different ways.
How do I avoid 20% down payment on investment property? ›
Yes, it is possible to purchase an investment property without paying a 20% down payment. By exploring alternative financing options such as seller financing or utilizing lines of credit or home equity through cash-out refinancing or HELOCs, you can reduce or eliminate the need for a large upfront payment.
Is it wrong to claim your investment property as a second home? ›
What Classifies as a Second Home. For financing purposes, there are criteria for a second home to be classified as such. First, it can't be an investment property meant to provide rental income. Secondly, the property cannot be located too near your current home.
Is a second home a good tax write off? ›
If you use the house as a second home—rather than renting it out—interest on the mortgage is deductible within the same limits as the interest on the mortgage on your first home.
How can I avoid capital gains tax on a second home? ›
A few options to legally avoid paying capital gains tax on investment property include buying your property with a retirement account, converting the property from an investment property to a primary residence, utilizing tax harvesting, and using Section 1031 of the IRS code for deferring taxes.
The 50% rule or 50 rule in real estate says that half of the gross income generated by a rental property should be allocated to operating expenses when determining profitability. The rule is designed to help investors avoid the mistake of underestimating expenses and overestimating profits.
What is the 80 20 rule in property investment? ›
InvestNext is a powerful ally for real estate investors seeking to understand and apply “What is the 80 20 rule in real estate.” This principle, which asserts that approximately 80% of outcomes (or outputs) are due to 20% of causes (or inputs), is crucial in the realm of real estate investment.
What is the 50% cash rule? ›
The 50% rule advises investors to estimate a property's operating expenses will amount to roughly half of its gross income. While this estimation proves helpful in projecting rental property cash flow, it is not a flawless measurement and should only ever be used as a starting point for further research and analysis.
What is the difference between property and investment property? ›
Owner-occupied property is property held (by the owner or by the lessee under a finance lease) for use in the production or supply of goods or services or for administrative purposes. 7 Investment property is held to earn rentals or for capital appreciation or both.
What is an example of an investment property? ›
Investment Property Explained
Such properties may be commercial, industrial or residential in nature that may include apartments, office spaces, warehouses, manufacturing plants, etc. The main aim is to earn profit when the value increases.
Is buying a second home considered an investment property? ›
If you plan to generate income from value appreciation or renting, your second home can become an investment property. Unlike conventional investment products such as mutual funds and stocks, purchasing a second home for investment entails additional costs like maintenance, insurance and property taxes.
Can I turn my second home into an investment property? ›
Can I convert a second home into an investment property? While converting a second home into an investment property may be tempting, there could be restrictions on doing so if you have a mortgage. Most lenders will require you to sign a document that states how you intend to use the property.
What are the disadvantages of owning a second home? ›
The downside of buying a vacation home is that you will have two of everything – mortgages, property tax bills, water bills, fuel bills, etc. It also means additional responsibility for repairs and general upkeep. At the same time, owning a second home can be very rewarding in tangible and intangible ways.
