Second Home Considerations: Tax Implications of Multiple Residences

Many people are drawn to the idea of purchasing a second home or rental property for potential tax benefits. However, it’s important to understand what truly applies and what’s often misunderstood.

Can You Deduct Rental Property Losses Against W-2 Income?

One common misconception is that you can deduct rental property expenses against your W-2 income. In most cases, you can’t. If the property is held in an LLC or another entity, those deductions stay within that entity. So, if you’re earning $300,000 in W-2 income, you won’t be able to offset that with deductions from your rental property.

Real Tax Benefits from Rental Properties

The real tax advantages of owning a rental or vacation property come from:

• Depreciation: You can write off the cost of the home over 27 years, reducing your taxable rental income.
• Deductions: Expenses like mortgage interest, improvements, and operating costs are deductible.
• Tax-Efficient Income: Rental income is often mostly offset by deductions, allowing you to collect cash flow with minimal tax liability.

What Happens When You Sell?

If you sell a rental property, you may face capital gains taxes. However, there are strategies to reduce or defer these taxes:

• Move back into the property for at least two years to potentially exclude gains under the primary residence rules.
• Use a 1031 exchange to defer capital gains by reinvesting in another like-kind property.

Second Homes Without Rental Use

If the second home is not rented out, you won’t receive depreciation benefits, but you can still deduct mortgage interest (if it exceeds the standard deduction). And, like any real estate investment, you’re building wealth outside of the stock market through property appreciation.

Where Does Real Estate Fit in Your Financial Plan?

Owning real estate can be a powerful way to build wealth, but it should come after:

• Paying off high-interest debt
• Maxing out 401(k) or retirement plan contributions
• Investing extra funds in a brokerage account

Once those are in place, investing in real estate can be an excellent way to diversify and grow your portfolio.

Want help optimizing your real estate strategy and taxes? Schedule a consultation with one of our Financial Advisors to create a financial plan that fits your long-term goals.