Mortgage interestThe main thing to consider when looking at mortgage interest deductions is how you are defining your second home: Is it a personal residence, an investment strategy, or a combination of the two? If your second home is exclusively for the enjoyment of you and your family (including your spouse, siblings, parents, grandparents, children and grandchildren), you can follow the same rules you would for your primary residence — mortgage interest can be deducted come tax time. The even better news for second home owners looking to make a little income is that you may be allowed to rent your property and still abide by the personal residence tax rules, all without having to pay taxes on the rental income. Just don’t go overboard — you can get the benefit only if you stay in your second home for more than 14 days, or more than 10% of the number of days you rent it out, whichever is longer. What’s more, as long as you follow the 14-day rule, you won’t be taxed on rental income no matter how high your rate is. Whether you rent it for $100 or $10,000 a night, that money can be excluded from your gross income.
Investment property deductionsA different set of rules apply if you never use, or only rent out, your second home. A home is considered a rental property rather than a personal residence if it is rented for more than 14 days per year and your personal use is 14 days or fewer per year (or 10% of the number of days the home was rented).In that case, your house is deemed an investment property and falls under a different set of second-home tax deductions. Investment properties don’t qualify for the mortgage interest deduction mentioned above, but special tax tactics can be applied, like an annual depreciation deduction. With the depreciation dedication, if a second home owner buys a property solely for investment or rental purposes, the IRS assumes the asset has a finite useful lifespan. That means the cost of the home can be deducted incrementally over a period of 27.5 years.
Property taxesUnlike the mortgage interest rule, you can deduct property taxes paid on your second home or, for that matter, as many homes as you own. However, the total of state and local taxes eligible for a deduction — including property and income taxes — is limited to $10,000 per tax return ($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.
Rental expensesIf your second home is exclusively a rental property, you can deduct a number of other expenses in addition to property taxes: utilities, insurance, housekeeping and property manager fees, repair costs, other rental expenses, and purchases like towels and sheets. Individually, these may not be costly, but they add up quickly and could be a substantial deduction.
It’s worth noting two things:
- If you also use your second home yourself, you must apportion these costs between your personal use of the property and the time it was rented.
- The days spent fixing and improving your second home do not count as personal use, so keep all maintenance receipts.