The Tax Difference in Second Homes

A principal residence and a second home have some similar benefits, but they have some key tax differences. A principal residence is the primary home where you live and a second home is used mainly for personal enjoyment while limiting possible rental activity to a maximum of 14 days per year.

Under the 2017 Tax Cuts and Jobs Act, the Mortgage Interest Deduction allows a taxpayer to deduct the qualified interest on a principal residence and a second home. The interest is reduced from a maximum of $1,000,000 combined acquisition debt to a maximum of $750,000 combined acquisition debt for both the first and second homes.

Property taxes on first and second homes are deductible but limited to a combined maximum of $10,000 together with other state and local taxes paid.

The gain on a principal residence retained the exclusion of $250,000/$500,000 for single/married taxpayers meeting the requirements. Unchanged by the new tax law, the gains on second homes must be recognized when sold or disposed.

Tax-deferred exchanges are not allowed for property used for personal purposes such as second homes. Gain on second homes owned for more than 12 months is taxed at the lower long-term capital gains rate.

This article is intended for informational purposes. Advice from a tax professional for your specific situation should be obtained prior to making a decision that can have tax implications.

When Neighbors Don't Seem to Care

A home that isn't being maintained like others in the neighborhood can negatively affect your visual sense of appeal and in some extreme cases, even affect property values. It might be an overgrown yard, a fence in need of repair, excessive noise, unruly pets, paint peeling on the home or even a car or boat parked in front of the home that hasn't moved in weeks.

Most people want to be good neighbors and may be willing to correct an issue once it is brought to their attention. A practical but possibly, confrontational solution is to contact the responsible person and describe your perception of the issue. However, they may not always agree with the same urgency and it might be necessary to seek other remedies.

An owner-occupant may be more sympathetic to the neighbors and willing to correct the issue. If you think the home might a rental property, check with the county tax records to identify the owner. They may be unaware of the situation and welcome the notification to protect their investment.

Another alternative might be to notify the homeowner's association, if there is one. One of the benefits of a HOA is to enforce community appearance standards as set in the covenants or bylaws that specify how properties must be maintained. This could be a less personal method of reaching a beneficial outcome.

If the source of the problem is a code or housing violation, the city may be the ultimate authority. Most cities have a separate code and neighborhood services division and some cities have 311 for non-emergency assistance.

Second Guessing Price

Imagine a homeowner consulting with their agent about the price to place on their home. The agent suggests that the market data indicates that $200,000 to 210,000 would produce a quick sale by pricing it properly. The owner puts a $210,000 price on the home.

The first person who looks at the home offers $205,000. When the seller receives the offer, he comments that he thinks he priced the home too low and counters for  full price. The counter-offer is rejected, the home stays on the market and at the end of the first month when based on market conditions, the home should be sold, no other offers have been made.

It may be human nature that when an offer is received so quickly, the first thought to come to mind is that it was priced too low. A more appropriate thought might be that it was priced correctly. In some cases, when a home comes on the market, there is increased competition (real or perceived) among the buyers waiting for the "right" home to come on the market. The home can sell for a higher price than if it sits on the market for several months.

There may be stories of sellers who turned down the first offer and ended up receiving a better offer that would net more money. However,  real estate professionals say the first scenario occurs frequently.

The wisdom of experience advises owners to find a real estate professional that they trust and have confidence. Allow that professional to become familiar with your home and compare it to similar homes in the market that have sold recently and ones currently on the market. Determine the demand for homes in the area compared to the inventory. Decide on a price that will allow the home to sell within a relatively short period of time. And lastly, be satisfied if your home sells quickly near the price you put on it.

A Home for Tomorrow

As people near or enter retirement, one of the decisions that typically comes up is whether to sell their "big" home and buy a smaller one. If you know anyone who has been faced with that situation, selling one home and buying a smaller one may not save enough money to make it worthwhile.

There are sales expenses on the property being sold and acquisition costs on the replacement home. Generally speaking, homeowners may not mind a home with less square footage, but they usually don't want to give up amenities or locations that they've become accustomed.

After a little number crunching, the move may not make enough difference in savings and they end up staying in their current home even if it doesn't fit their needs anymore.

What if while this couple were still in their peak earning years, they acquired a home in an area where they would consider retiring and rent it during the interim. They could put it on a 15-year mortgage and possibly, even accelerate the principal payments to have it paid off by their anticipated move.

In the meantime, they could continue living in the "big" home until it is time to make the transition. Sell the "big" home that may be paid for by then and avoid up to $500,000 of capital gain. Take part of the proceeds and remodel the rental/transitional home and invest the proceeds for retirement income.

Ideally, the former rental would be mortgage free by this point, so the retirees would not have a house payment. Even if at this point, they changed their mind about retiring to this particular home, they still have a property that acted as a hedge against rising prices and have sufficient equity to purchase something else without using the proceeds from the "big" home.

It is difficult to know what the situation will be years from now when a person retires. It is clearly advantageous to have a plan that allows for options and choices. To find out more about purchasing your retirement home today, give me a call at (256) 705-0733.

Overlooked Recordkeeping

Homeowners are familiar that they can deduct the interest and property taxes from their income tax returns. They also understand that there is a substantial capital gains exclusion for qualified sales of up to $250,000 if single and $500,000 for married filing jointly. However, ongoing recordkeeping tends to be overlooked.
New homeowners should get in the habit of keeping all receipts and paperwork for any improvements or repairs to the home. Existing homeowners need to be reminded as well, in case they have become lax in doing so.
These expenditures won't necessarily benefit in the annual tax filing but may become valuable when it is time to sell the home because it raises the basis or cost of the home.
For instance, let's say a single person buys a $350,000 home that appreciates at 6% a year. Twelve years from now, the home will be worth $700,000. $250,000 of the gain will be exempt with no taxes due but the other $100,000 will be taxed at long-term capital gains rate. At 15%, that would be $15,000 in taxes due.
Assume during the time the home was owned that a variety of improvements totaling $100,000 had been made. The adjusted basis in the home would be $450,000 and the gain would only be $250,000. No capital gains tax would be due.
Some repairs may not qualify as improvements but if the homeowner has receipts for all the money spent on the home, the tax preparer can decide at the time of sale. Small dollar items can really add up to substantial amounts over many years of homeownership.
You can download a Homeowner's Tax Worksheet that can help you with this recordkeeping. The important thing is to establish a habit of putting receipts for home expenditures in an envelope, so you'll have it when you are ready to sell.

Costs More - Takes Longer

The one experience that homeowners can agree upon after completing a remodeling project is that it costs more and takes longer than expected. It doesn't really matter that you researched, planned, and received multiple bids, it will, invariably, cost more and take longer than you originally anticipated.

Replacing floorcovering or painting is a project that a homeowner can easily get bids and contract with the workmen directly. A new level of complexity occurs when the project involves more specialized contractors, like plumbers, electricians, carpenters, counters, and others.

Now, a homeowner is faced with dealing with one general contractor who will run roughshod over the sub-contractors or make the decision to do it themselves. Typically, you'll pay more for a general contractor, but the trade-off is that they have the contacts and experience to make things go smoothly.

Subs are notorious for wanting to finish their "part" of the project and move onto to the next job. Sometimes, they're not interested in the "big picture" enough to consider doing things in a way that are best for the overall outcome.

When you start tearing out some things, you find out that there may be unexpected expenses involved. Another common occurrence is that during the project, you get a new thought about changing something else "since it is already torn up anyway." This will add time and money to the job.

There can be the situation that the homeowner doesn't even know the right questions to ask or what to consider when trying to coordinate the different workers. The most detailed timetable can be thrown off track if one set of workers don't show up or finish on time. At best, it delays the project for a few days. At worst, it can delay it for a few weeks because the individual workers may have committed to other jobs that don't allow them to reschedule.

Once the work is done in a professional manner, you're probably going to live with it for years. If it is something you've wanted to do and it will allow you to enjoy your home more, it is worth doing. Just be patient and enter this adventure with the understanding that it will cost more and take longer than you expect.

Case Study - Housing Decision During Retirement

A couple is planning to tour the United States in a travel trailer during their first few years of retirement. They are going to sell their current home now and purchase another home when they finish their travels.

An interesting exercise is to determine the optimum time of selling the home: now or when they're ready to buy their replacement home.

If they intend on traveling for more than three years, then, it may be a good decision to sell prior to the sojourn to avoid paying taxes on the gain in their home. IRS allows for a temporary rental of a principal residence while still keeping the $250,000/$500,000 capital gains exclusion intact. A homeowner must own and use a home for three out of the previous five years which means that it could be rented for up to three years, but it would need to be sold and closed before that three-year window expires.

If the travel will be less than three years, there is an option of selling now or later. Using the example below, the homeowner sold the home, paid their expenses and invested the proceeds in a three-year certificate of deposit until the replacement home was purchased.


As an alternative, if the homeowner rented the home, not only would they have income, the home would continue to appreciate and the unpaid balance would go down resulting in larger net proceeds. Based on a 5% appreciation and continued amortization of the mortgage, the net proceeds could easily be $40,000 more.


Obviously, there are a lot of considerations that affect the decision to sell now or later but in an appreciating real estate environment, being without a home for several years could affect the financial position of the owner in the replacement property. It is certainly reasonable to look at various alternatives before making a decision. Call me at (256) 705-0733 to help you look at the different possibilities and talk to your tax professional.