9 Tax Issues You Must Understand Before You Buy a Second Home

Buying a second home can feel like a dream come true. However, although there are many things to love about a vacation getaway, it's also important to consider the tax impact of such a purchase.

Knowing the rules before you buy — or even after — can help you make tax-efficient decisions regarding the property.

To eliminate some money stress, make sure you understand these tax facts when purchasing a second home.

If you use the house as a second home or vacation property, you may be able to deduct some of the mortgage interest from your taxable income.

As of 2018, you can generally deduct interest on mortgage debt of up to $750,000 across your first and second homes.

Of course, that means you'll only be able to take an interest deduction on your second home if you don't already have $750,000 in mortgage interest associated with your primary home.

It's worth noting that the amount of mortgage interest you can write off has decreased in recent years.

Prior to 2018, you could deduct mortgage interest on up to $1 million of mortgage debt and up to $100,000 of home equity debt, for a total of $1.1 million in mortgage-related debt.

But in 2018, this interest deduction cap shrank to the interest paid on up to $750,000 in mortgage loans originated after Dec. 16, 2017. Homeowners with older loans may still have the option of deducting $1 million in mortgage-related debt.

Although the amount of interest you can deduct has decreased, the available deduction remains a substantial perk for some taxpayers.

Just as you can deduct the property taxes on your primary home, you also can deduct the property taxes you pay on a second home.

However, there is a limit to how much you can deduct, as we will discuss next.

The current limit on property tax deductions is $10,000 per tax return across both your primary residence and second home.

That means if your property taxes are especially high on your primary home, a property tax deduction for the second home might not be in the cards.

If you plan to rent out the second home infrequently, you might be able to pocket the funds without paying income tax.

In order to skip reporting rental income, you can only rent out the home for 14 days or fewer each year. If you rent the home for more than 14 days, you'll need to report the income to the IRS.

If you rent out the property for more than 14 days, you must report the rental income to the IRS. Although you'll pay taxes on the rental income, you do get the opportunity to deduct the expenses related to the rental.

For example, if you incur cleaning fees or property manager costs to facilitate renting out your second home, you can write off these expenses.

When you sell the rental property, the profit generated is called a capital gain. If you don't use the property as a primary residence, you'll owe capital gains taxes when you sell the property.

For example, if you buy a home for $100,000 and sell it for $300,000, you have generated a capital gain of $200,000. Since it's a second home, you'll owe capital gains taxes on the profit of $200,000.

The major way to limit capital gains taxes is to live in the home as a primary residence for at least two out of the five years leading up to the sale.

When you sell a primary residence, the capital gains tax home sale exclusion allows individuals to shield up to $250,000 of profits — or $500,000 for married couples filing jointly — from taxes.

Homeowners planning to sell a second home in coming years might want to spend enough time in the second home to have the property count as their primary residence. Meeting the residency requirements can score you big tax savings.

If you want to pass down the second home to your family, the gift may come with tax consequences.

In 2025, the lifetime gift and estate tax exemption will be $13.99 million per individual and $27.98 million for married couples. But this exemption is set to drop by half in 2026, unless the new president and new president extend it.

Depending on the size of your estate, the lower exemption limit could pose a problem if you plan to give an expensive vacation property to heirs.

When your heirs inherit a vacation property that exceeds the lifetime gift and estate tax exemption, they may face hefty estate taxes.

Although a second home can add a lot of joy to your life, there are tax implications to consider. Understanding the rules can help you make smart homeowner moves that limit your tax liabilities.

If you want help navigating a complex tax situation, don't hesitate to work with a tax professional.