Tax Benefits of a Second Home vs Investment Property - Advanced Tax Advisors (2024)

One of the most important factors to consider when deciding whether to purchase a second home or an investment property is the tax implications. Not all real estate is created equal in the eyes of the IRS, and there are different rules for each type of property. Here is a breakdown of the tax benefits of a second home vs an investment property to help you make the best decision for your needs.

The first thing to understand is that there are two types of income from real estate: passive income and active income. Passive income is generated from rental properties and generally speaking, is taxed at a lower rate than active income. Active income, on the other hand, is generated from flipping houses or other activities where you are regularly engaged in the business of real estate.

Now that we have got that out of the way, let us take a look at the specific tax benefits of each type of real estate.

Second Homes

When it comes to taxes, there are some distinct benefits that come with owning a second home. If you are considering purchasing a second home, it is important to be aware of these potential tax breaks so that you can make the most of them.

Here are some of the key tax benefits of owning a second home:

Mortgage Interest and Property Taxes

One of the biggest tax benefits of owning a second home is that you can deduct mortgage interest and property taxes on your federal income taxes. This can amount to significant savings over time, particularly if you have a high-interest rate mortgage. Additionally, if you itemize your deductions, you can also deduct state and local income taxes, which can further increase your savings.

Home Equity Debt

Another benefit of owning a second home is that you can deduct interest on your home equity debt. The amount that you can deduct changes based on when the home was purchased. This is an important benefit because it allows you to improve or repair your primary residence or second home without incurring additional taxes on the debt. However, it is important to note that this benefit is only available if the debt is used for qualifying purposes such as renovations or repairs.

Capital Gains Exclusion

Finally, one of the most beneficial tax breaks for second homeowners is the capital gains exclusion. This exclusion allows you to exclude up to $250,000 in capital gains (or $500,000 if you’re married and filing jointly) when you sell your primary residence. To qualify for this exclusion, you must have owned and lived in the home for at least two out of the past five years. This exclusion can save you thousands of dollars in taxes when you sell your home, so it’s definitely something to be aware of if you’re thinking about purchasing a second home.

Investment Properties

If you are looking to purchase an investment property vs a second home there are different deductions available to you. You will also need to qualify for real estate professional status every year to reap the full benefits.

Mortgage Interest Deductions

One of the most common deductions for investment property owners is mortgage interest. If you have a mortgage on your investment property, you can deduct the interest you pay on that mortgage from your taxable income. This is a great deduction to take advantage of because it can significantly reduce your tax bill.

Depreciation Deductions

Another deduction that is available for investment property owners is depreciation. When you own an investment property, you can depreciate the value of that property over time. This deduction can be taken even if you do not actually sell the property.

Operating Expense Deductions

Investment property owners can also deduct a variety of operating expenses from their taxable income. These expenses can include things like repairs and maintenance, insurance, and property taxes. By deducting these expenses, you can further reduce your tax bill.

As you can see, there are distinct tax benefits associated with each type of real estate. When deciding whether to purchase a second home or an investment property, it is important to consult with a qualified tax strategist to determine which option will provide the greatest tax benefit for your specific situation.

Jose A. Ramirez is an experienced and sought-after tax strategist who helps investors through the process of cost segregation. He specializes in Short-Term Rentals such as AirBNB and VRBO, Landlords, Wholesalers, Rehabbers, Flippers, Real Estate Brokers, and Realtors. Schedule an appointment with Jose A. Ramirez for any additional questions you may have about this recent event. Make sure you are subscribed to the Advanced Tax Advisors email list so you can receive Real Estate Investor tips just like this in the future.