Buying a second home is exciting. Your second home opens doors to all kinds of opportunities; you can turn it into a rental property for extra income, fix it up and use it as an investment, use it as a weekend getaway, or all three. However, each of these decisions has tax implications. Before you buy your second home, knowing critical second home tax deductions and laws can help you avoid unnecessary costs and, in some cases, even lower your tax bill.
Note: These are guidelines for deductions that may be available, not financial advice. Consult with a tax professional before using any second home deductions.
Know These Second Home Tax Deductions and Laws Before Buying
1. Capital Gains On Second Homes
The way capital gains work is different for second homes compared to your principal residence. If you live in the home, you can exclude up to $250,000 in capital gains on the sale ($500,000 for you and your spouse). This is not true for a second home, and therefore can affect how you use it.
Some homeowners try to realize a second home tax deduction on capital gains by living in the second home for at least two years prior to sale. This would have worked before 2009, but the Housing and Economic Recovery Act (HERA) changed second home capital gains taxation calculations. For second homes, capital gains are taxed by the amount of time you didn’t live in the home (after 2009). This means the best way to reduce second home capital gains tax is to invest in a property you will one day live in, such as a home you plan to retire in.
2. Second Home Tax Deductions On Home Improvements
If you purchased a fixer-upper, whether as an investment or to eventually retire in, you can use some second home tax deductions on home improvements.
Some home improvement tax deductions are only available for properties you live in, but others are available to any property. If any of the following examples sound familiar, you may qualify for a second home tax deduction.
- You pay for your aged mother’s care and expenses, and she lives in your second home. You install a wheelchair ramp, railings, and other modifications to make the home safe and accessible for her. These home improvements may be tax deductible medical expenses on an itemized return.
- You install a solar system, solar water heater, geothermal heat pump or wind energy system in your second home. You may qualify for a Residential Energy Efficiency Property Credit as a second home tax deduction.
- You make upgrades to your second home so you can meet clients or work there. These improvements may qualify as a home office deduction.
- You renovate your second home to make it a safe and attractive rental property. These may be deductible rental expenses.
3. Second Home Mortgage Interest Deduction.
If the mortgages on your first and second home total less than $750,000 and you itemize your return, your mortgage interest may be deductible. When managing a second mortgage, this can be an especially helpful second home tax deduction.
Keep in mind that this $750,000 limit began in 2018, and the previous limit of 1 million may affect the mortgage on your first home. You can also deduct interest on loans you take out to improve your home, but separate limits apply.
4. Second Home Property Tax Deduction
In 2017, an unlimited amount of state and local property tax on all real estate could have been deducted on your itemized federal taxes. As of 2018 there is a cap, though it is still possible to claim this second home tax deduction. If the total property taxes on your first and second home are less than $10,000, you can deduct these taxes if you itemize.
5. Tax Cuts and Jobs Act
The Tax Cuts and Jobs Act (TCJA) instated significant tax code changes. In addition to those previously mentioned, the following changes can affect your tax return for the 2018 taxable year, particularly whether or not it is beneficial to itemize your return (which impacts your decision to use other deductions and credits which require itemization).
Major TCJA Changes:
- Standard deduction for individuals rises from $6,350 to $12,000 ($24,000 for married filing jointly).
- Personal exemption of $4,050 is eliminated.
- Tax brackets have been adjusted.
- Estate tax exemption (exemption on taxable inheritance) doubled to 11.2 million.
- Contributions and income limits for retirement plans have been adjusted.
Knowing the right second home tax deductions and laws can save you thousands in the long run, and it will also keep you from making costly tax mistakes. Before buying your second home, consider carefully what you want it or need it for, or what it could be used for. This will help you find the right home and second home tax deductions.
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