Are you thinking about ways to increase your income and build wealth? For some investors, buying a second or rental property can fit that bill. But what’s the difference between a second home vs. an investment property? A second home may be easier to manage and gives you another place to use as you wish, for family and friends or other work. But an investment property is a way to make passive income and offers some tax benefits.
To help you understand the investment property vs. second home distinctions, let’s break down the differences.
Investment properties differ from primary residences or second homes. The investment property definition includes:
So how do you know if you have a second home vs. an investment property? The most important thing to consider is how you’ll use your property. Purchasing real estate for a profit instead of personal use would be considered an investment property.
By contrast, a second home is a residence you intend to occupy for part of the year in addition to your primary residence. Second home occupancy requirements are non-negotiable, and you must intend to personally occupy your second property for some period of time. In most circumstances, a second home is used as a personal vacation home. But it can also be a place to work or let relatives use.
One of the advantages of second homes is that you may be able to more easily obtain a mortgage. Second home vs. investment property interest rates are often lower and might include a second home rider along with the mortgage. In this economic environment, any interest rate reduction you can get can equal big savings. A second home rider usually states the following:
When investigating what is considered a second home for mortgage purposes, be sure to check with several different lenders about their individual requirements. In some states or with some lenders, the property must be located in a resort or vacation area to qualify as a second home vs. an investment property. Often this means a location like the beach, mountains, or near some kind of attraction more than 50 miles from the borrower’s home.
To recap, an investment property is a property you buy to generate income. Typically, you would rent the property to tenants for a long or short-term profit or flip it and sell it for a profit. Meanwhile, a second home is a property that you intend to reside in for part of the year or visit periodically.
In addition to different mortgage types, there are different tax benefits of owning a secondary home vs. an investment property. We’ll discuss these in depth below, but you should know that investment properties can offer you tax deductions by claiming operating expenses and ownership. Second homes can also generate rental income and tax deductions for expenses; however, there are limitations to this. The owner must also live at the property for a minimum of 14 days a year or 10 percent of the total days rented.
It’s generally cheaper and easier to get approved for a second home mortgage versus an investment property loan. Lending requirements for both types of properties are more stringent than they are for primary residences. And mortgage rates for a second home versus an investment property can differ quite a bit.
Lenders usually charge higher interest rates for second homes and investment properties due to the risk that borrowers would prioritize their primary homes if hard financial times hit. If you’re making a low down payment or have a low credit score, the rate difference could be even higher.
Is a second home considered an investment property for tax purposes? Not quite. The tax benefits of investment properties and second homes are different. Case in point: expenses for personal residences, whether they’re a primary or secondary home, usually aren’t deductible. But if you have an investment property, such as a house you’re renting, you can write off various expenses (for example, maintenance costs).
So what is considered a second home for tax purposes? If you rent out your property — including a second home — for 14 days or fewer each year, the income isn’t usually taxable at the federal level. However, you will have to pay federal income tax on your net rental income if you rent out your property for more than 14 days annually. Be sure to check your mortgage contract to ensure you’re able to rent out your second home at all.
In some cases, mortgage interest is deductible for a second home. If you own an investment property, you can lower your taxable income by deducting mortgage interest as a business expense.
Investment properties come with a few extra hurdles and benefits. If you buy an investment property, you may be able to add up to 75% of your expected rental income to offset the mortgage payment. However, not every buyer qualifies for this arrangement. Lenders offering this option may require a specialized appraisal and proof of experience as a landlord.
An exception to this requirement is the Federal Housing Administration (FHA) loan program. If you’re an FHA-approved lender, then FHA guidelines allow you to apply anticipated or actual rental income to the mortgage on a two- to four-unit property to your total income. You don’t need to show proof of previous landlord experience, either; however, you must live in one of the units for at least 12 months to be eligible for this type of financing.
When considering an investment in real estate, you should consider some things besides taxes and mortgages. You’ll also want to think about how much you want to spend, where you’d like to invest, and what’s important to you as a buyer. Some questions to consider include:
Once you’ve considered these questions, you can start your search. A buyer’s agent in your desired area can help you get started. Getting pre-approved for financing can jump-start the process, as well.
If you own and rent out your property, whether this is your first foray into real estate investment or you’re an experienced landlord, it’s worth forming a rental property LLC. Your rental property LLC works like the roof over your investments: once constructed, it protects you from exposure. We can help you set up an LLC that protects your assets from lawsuits associated with your property. A rental property LLC can mean if a tenant, guest, or delivery person sues you for things that happen on your property, only your property is at stake — not your life’s savings.
Our LLC formation service is an excellent resource to get property investors up and running quickly once you decide you want to protect your assets with a rental property LLC. Additionally, our full suite of business services and tools support you while you get started and help your business grow and thrive. Let us take care of formation, tax elections, compliance, and more, so you can focus on your property and building wealth.
Disclaimer: The content on this page is for informational purposes only and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
The main difference between a second home and an investment property is that a second home is generally for your use, and an investment property is something you intend to rent out or flip. A mortgage broker or tax professional can tell you about more differences between the two types of properties and how you can decide to best use your real estate investment.
No, buying a second home isn’t automatically considered purchasing an investment property. Your property type depends upon many things, including how you intend to use the property.
While nobody likes paying taxes, your property may be subject to a variety of different types of tax, like property tax and income tax on rental income. Speak with your tax professional about ways to minimize your tax burden.
A second home is a home you intend to reside in for part of the year, in addition to your primary residence.
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