What Is a Second Home? Financing and Tax Rules

A second home expands living options beyond a primary residence. They can serve as a vacation retreat or a convenient base closer to work or family. Understanding its characteristics is important, as they influence financing and tax obligations. Acquiring and maintaining a second home involves distinct considerations compared to a primary residence or investment property.

Understanding Second Home Classification

A second home must meet specific criteria to differentiate it from a primary residence or an investment property. Lenders and the IRS classify it based on owner occupancy and rental limitations. It is generally a single-unit dwelling suitable for year-round use that the owner occupies for a portion of the year, even if only seasonally. It cannot be part of a mandatory rental arrangement or a timeshare, nor can it be managed by a property management company that controls its occupancy.

The IRS considers a property a second home if visited for at least 14 days per tax year, or 10% of the days it is rented out. Lenders often have stricter occupancy rules. Some guidelines suggest the owner must utilize the property for personal purposes for at least half of the year.

Lenders typically require a second home to be located a certain distance from the primary residence, often at least 50 miles away. This distance helps prevent classification as an investment property, which carries different financing and tax implications. If a property is too close to the primary residence, or if it is rented out full-time, it will generally be considered an investment property, not a second home.

Misrepresenting a property’s intended use can lead to legal and financial consequences. For example, if a property is rented out for more than 180 days per year, lenders and the IRS may view it as an investment property, even if the owner uses it occasionally. A second home must not primarily generate rental income, although short-term rentals are often permissible within certain limits.

Securing Financing for a Second Home

Obtaining a mortgage for a second home differs from financing a primary residence due to higher perceived risk for lenders. Lenders view second homes as less essential, meaning borrowers might prioritize primary residence payments during financial difficulties. This increased risk leads to stricter qualification standards: higher down payments, elevated credit scores, and potentially higher interest rates.

A minimum down payment of at least 10% is generally required for a second home, with many lenders preferring 20% or more. This contrasts with primary residences, which may allow down payments as low as 3% to 3.5%. A larger down payment can help secure a more favorable interest rate and demonstrates commitment to the purchase. Lenders may also require borrowers to have cash reserves, often two to six months, to cover both their primary and secondary mortgage payments, property taxes, and insurance.

Credit score requirements for second home mortgages are typically more stringent. While some lenders may consider scores as low as 620, a FICO score of 640 or higher is generally expected, and scores of 680 or even 720 are often preferred for the best rates and terms. A higher credit score signals financial responsibility and can lead to more favorable interest rates. Additionally, debt-to-income (DTI) ratios are closely scrutinized; while they can vary by lender, a DTI of 45% or lower is often ideal, ensuring the borrower can manage the additional debt.

Conventional loans are a common financing option for second homes. Jumbo loans are also available for properties exceeding conforming loan limits, though these typically require a higher down payment, often 20% or more. Borrowers might also use home equity from their primary residence through a home equity loan or a home equity line of credit (HELOC) to fund a second home purchase or its down payment. However, these options use the primary home as collateral, carrying the risk of foreclosure if payments are not met.

Interest rates for second homes are generally 0.25% to 0.50% higher than those for primary residences due to the increased risk lenders assume. This difference reflects the lender’s assessment that a borrower is more likely to default on a second home loan than on the mortgage for their primary residence if facing financial hardship. Unlike primary residences, government-backed loans like FHA or VA loans are generally not available for second homes, as these programs are designed for primary residences.

Tax Considerations for Second Home Ownership

Owning a second home has various tax implications depending on its use. Property taxes are a universal consideration for all homeowners. These taxes are generally deductible, but they fall under the state and local tax (SALT) deduction cap, which limits the total deduction for property taxes, state income taxes, and sales taxes to $10,000 per tax return. If this cap is already met by primary residence taxes, there may be no additional deduction for second home property taxes.

Mortgage interest deductibility is another important aspect. For homes purchased after December 15, 2017, the interest on up to $750,000 in combined mortgage debt across both a primary and a second home can be deducted. This limit applies to “acquisition indebtedness,” meaning the loan must be used to buy, build, or substantially improve the home. If the mortgage was taken out on or before December 15, 2017, the limit for combined mortgage debt is $1 million. Interest on home equity loans or HELOCs used for personal purchases, rather than home acquisition or improvement, is generally not deductible.

Tax treatment changes if a second home is rented out. If the home is rented for 14 days or fewer during the tax year, the rental income is typically tax-free, and the owner can still deduct mortgage interest and property taxes under the rules for a second home. This is often referred to as the “Masters Rule.” However, if the property is rented for more than 14 days, all rental income must be reported, and expenses related to the rental use, such as depreciation, maintenance, and utilities, can be deducted.

For properties used as both a personal residence and a rental, expenses must be allocated between personal and rental use based on the number of days used for each purpose. The IRS has specific guidelines for mixed-use properties to determine if they are primarily personal or primarily rental.

When selling a second home, capital gains tax considerations apply. Unlike a primary residence, which may qualify for a significant capital gains exclusion ($250,000 for single filers, $500,000 for married filing jointly), a second home is generally treated as an investment property for capital gains purposes. This means the entire gain from the sale may be subject to capital gains tax, unless the property was converted to a primary residence and lived in for a specific period before the sale. The tax rate on these gains depends on how long the property was owned, with long-term capital gains rates applying to properties held for more than one year.