Key takeaways
- An investment property isn’t the same as a second home or vacation home when it comes to the mortgage and your taxes.
- For an investment property, mortgage lenders impose stricter qualifying criteria compared to second homes — but both investment property and second home mortgages are harder to come by compared to a loan for a primary residence.
- Depending on how you use the property, it’ll be classified as either an investment property or a second home, with respective tax benefits and drawbacks.
If you’ve been comparing mortgage rates for second home vs. investment property loans, you’re already on a promising path: You’ll either have a place to go for vacations or one that’ll generate income and put more money in your pocket. Either way, the opportunity to own more than one property is an enviable position to be in, but how you classify that property makes a difference in how much you’ll pay to finance and own it.
When determining whether to buy a vacation home vs. an investment property, this is what you need to know.
Second home vs. investment property definitions
There is a key difference between second home and investment property loans, and it all has to do with how you plan to use the 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.
It might be confusing to differentiate between a second home versus investment property. That’s true especially if you’re thinking about occasionally renting out the property — using it regularly for vacation, for example, but also making it available on Airbnb for some of the time you’re not using the property.
Earning some money from your property doesn’t automatically make it an investment, however. Accurately defining the piece of property depends on how much time you spend in it.
Pay attention to “the 14-day limit rule,” says Elliot Pepper, co-founder, CFP and director of Tax Services at Northbrook Financial in Baltimore.
Very broadly speaking, if you personally live in your second home for 14 days or fewer — or less than 10 percent of the days it is rented — during a year, then it would be considered a rental property and the income earned would be taxable, but you would also deduct the expenses associated with the property.— Elliot Pepper, co-founder, CFP and director of Tax Services at Northbrook Financial in Baltimore
On the flip side, if you use the property for more than 14 days or more than 10 percent of the time it’s rented, any rental income you receive isn’t taxable, but you also can’t deduct expenses, says Pepper.
Second home vs. investment property mortgage requirements
| Second home lender requirements | Investment property lender requirements | |
|---|---|---|
| Credit score minimum | 620-680 or higher | 700 or higher |
| Down payment minimum | 5%-10% | 15%-25% or more |
| Debt-to-income (DTI) ratio maximum | 45% | 45% |
Making the distinction between a second home and investment property is important not only for tax purposes but also when you seek financing for the home.
Both types of properties are riskier prospects for lenders. That’s because if you were in a financial bind, you’d likely prioritize paying the mortgage on your primary home versus a second or investment property.
Due to this added risk, lenders tend to require higher credit scores and down payments on investment property and second home mortgages. For instance, Chase and Navy Federal Credit Union both require a 15 percent down payment for an investment property.
Second home vs. investment property tax implications
There are some tax rules to keep in mind when considering a second home vs. investment property loan.
Second home tax rules
- Mortgage interest is tax-deductible if it falls within the $750,000 total debt limit
- Cannot rent out your property for more than 14 days per year to deduct mortgage interest
Investment property tax rules
- Mortgage interest is fully tax-deductible
- Can also deduct many expenses related to the property, including property taxes, maintenance, advertising to attract renters, materials and supplies used to maintain the property, utilities and insurance, as well as for depreciation
- If you rent out the home for more than 14 days per year, the rental income is taxable
Homeowners enjoy the ability to deduct mortgage interest, but Pepper points out that this can get a bit tricky if you own a second home, due to the $750,000 total debt limit for interest deductions. Essentially, if you have more than $750,000 in mortgage debt between the two (or more) properties, you’ve maxed out the amount you can use to deduct interest.
However, “interest on a mortgage related to an investment property is fully deductible on [Form 1040] Schedule E for a taxpayer and can therefore be used to offset any income generated from the property,” says Pepper. “Investment property owners can use depreciation to their advantage, as well.“
For a personal residence, the owner is not allowed to deduct the actual cost of the home for tax purposes, says Pepper. “However, for an investment property, the taxpayer will be allowed to take a deduction every year for depreciation. This deduction is based on the price of the house purchased and will be used to offset any income from the property.”
Pepper notes that this deduction isn’t a permanent write-off, “as the amount of depreciation taken will reduce the basis in the house. When the taxpayer goes to sell, they may end up with a larger tax gain that year.” This gain, known as depreciation recapture, is taxed at higher rates than traditional long-term capital gains.
In addition, whenever the selling year arrives, an investment property owner can be subject to income tax if the sale results in a profit, Pepper says.
For more on the tax implications of second homes and investment properties so that you can calculate your eligibility for tax deductions, review IRS Publication 936 and Publication 527.
Second home vs. investment property mortgage rates
As they have with primary residences, mortgage rates for second homes and investment properties have increased this year. You’ll also pay higher rates, in general, for investment properties and second homes than you will for a primary residence mortgage loan.
To get a better idea of how interest rates compare, check out the latest rates for both second homes and investment properties:
- Compare second home mortgage rates
- Compare investment property mortgage rates
Can you call an investment property a second home?
Tempted to call your investment property a second home and take advantage of some of the second-home perks, like a lower down payment and interest rate? Don’t be. In the mortgage world, you need to call it what it is. Deceiving a lender or the IRS otherwise could have serious consequences.
