Co-ownership 411
Published Date: April 25, 2023
Luxury second homes
Understanding tax laws and your second home
A second home is a personal residence for part of the year. The rest of the time it may remain vacant or be rented out to guests. Here are other common characteristics of second homes:Usually far away from an owner’s main residence
Vacation homes are typically located in another city or state. In fact, some mortgage lenders require that a second home be at least 50 miles from the owner’s primary residence. Otherwise, it may be considered an investment property.Often purchased after a main residence is paid off
Buyers may purchase a second home for retirement or to vacation in another part of the country. It’s not required for a first home to be paid off before buying a second home, however.Include tax benefits for owners
Reserving your second home for family-only use rather than using it as a rental property keeps things simpler at tax time. Like a primary residence, you can deduct a portion of your second home’s mortgage interest and property taxes.Tax benefits of second homes
Second homes come with a host of possible tax benefits from the IRS, but they depend on two key factors: whether you’re living in your second home more than you rent it out and how much money you’re taking in income from tenants. Let’s dive into the specifics:Mortgage interest deduction
If you rent out your home for less than 15 days a year, it’s considered a personal residence and you’re eligible for itemized deductions like any other homeowner. You can deduct mortgage interest up to $750,000 on principal for properties purchased after 2020. Rental income (under the 15-day limit) is also exempt, so you don’t need to report earnings to the IRS.Home equity interest deduction
Staying 14 days per year means your second home is considered a residence. In addition to deducting mortgage interest, you may also be able to write off interest paid on a home equity loan. To qualify, you’ll need to have a mortgage on your second home and use the home equity loan for property improvements.Property tax deduction
You can deduct property taxes on your second home, but if you take a property tax deduction on your first home, you may be ineligible to claim another for your second residence. There’s a limit of $10,000 per tax return (or $5,000 per person if married and filing separately).Example: Greg and Rodney live in Michigan and purchase a second home in Arizona to enjoy every winter. The home stands empty during the summer unless Rodney’s kids stay there. Since Greg and Rodney stay more than 14 days and have no renting income, they benefit from the same homeowner deductions as their first home.Takeaways
- Owning a second home has personal and financial benefits, including tax deductions.
- You’ll pay real estate taxes on each home, but some can be deducted.
- Renting out your second home can affect how you report ownership to the IRS.
In more detail:
How is a second home different from an investment property?
Investment properties are purchased for the sole purpose of generating income. Unlike second homes, investment properties are usually rented out full time to tenants or as vacation rentals. They are subject to stricter lending terms than owner-occupied second homes.Can you change a property from a second home to an investment property?
If you change your mind about your property and want to rent out your second home, you can change your occupancy status. It’s best to do this after you’ve owned property for at least a year, and you’ll need to report any new rental income to the IRS.What happens if I decide to sell my second home?
Selling a second home is a different experience than selling your primary residence. Your first home earns you capital gains exclusions: Single tax filers can exclude $250,000, and couples filing jointly can exclude up to $500,000 on their return. That isn’t the case for second homes. The IRS sees secondary properties as investments, meaning that unless you’ve lived there for an extended period of time before the sale, you may pay up to 20% in capital gains tax.Does the IRS view a Pacaso as a second home?
Yes, because your Pacaso is a single-family residence that you own. By buying a share in a property-specific LLC, you gain a second home that you share with fellow co-owners. You’ll be guaranteed at least six weeks of time in your second home. Also, as listed in the owner agreement, Pacaso homes may not be rented out. You’ll always have the peace of mind that your second home is reserved for you, your small group of LLC co-owners and registered guests.
Kayla Moses
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I'm well-versed in co-ownership structures, real estate tax implications, and property investment dynamics. In the realm of co-ownership, understanding the IRS's criteria for a second home is crucial. Meeting specific visitation requirements—14 days annually—or utilizing the home for at least 10% of the days rented out distinguishes a property as a second home, significantly impacting tax implications.
This distinction between personal and rental use affects taxes variably. Rental income, usage patterns, and ownership structures determine the deductions and benefits one can leverage. For instance, owners can deduct mortgage interest up to $750,000 on principal for properties bought after 2020, along with property tax deductions (capped at $10,000 per tax return).
Additionally, transitioning a property from a second home to an investment property isn't just a change in usage—it entails altering how the property is reported to the IRS. This shift is advisable after owning the property for at least a year and involves reporting any new rental income.
When selling a second home, unlike primary residences that enjoy capital gains exclusions of up to $250,000 (single filers) or $500,000 (joint filers), the IRS views secondary properties as investments. Unless you've lived there extensively before the sale, you might face capital gains taxes of up to 20%.
Regarding the Pacaso model, it functions within the IRS's definition of a second home. Owning a share in a property-specific LLC aligns with co-ownership, guaranteeing time in the second home and precluding rental activities as per the owner agreement.
This understanding of tax laws and property dynamics underscores the complexity and financial nuances of second-home ownership, making informed decisions imperative.
The concepts covered in the article touch upon:
- Criteria for IRS classification of a second home.
- Distinction between second homes and investment properties.
- Transitioning a property from a second home to an investment property.
- Tax implications upon selling a second home.
- Pacaso model's alignment with second home classification and co-ownership dynamics.
