Owning a home is the ultimate definition of the American Dream. But for so many homeowners, branching out and acquiring a second property has opened the door for new possibilities and new dreams. Of course, owning more than one property brings a new set of responsibilities and expectations to the investor, depending on what the other property is going to be used for. So, what really defines the difference between a second home and an investment property? Read on!
What makes a property an investment property?
An investment property is a building or land that is used to generate income, instead of being occupied by the owner. The property can be a residential rental home, a commercial space for business use, or a mixed-use property, such as a retail storefront with apartments on the upper levels. Many investment properties are homes intended for flipping, in which the investor purchases a fixer-upper home, remodels it, and resells it for a profit within a short time. In addition, an investment property branches out beyond just buildings. It can include farm ground that’s rented or leased to farmers, timber acreage that hunters pay to use, or even privately owned parking lots that collect parking fees.
When the term “investment property” is mentioned, it typically conjures thoughts of a landlord-tenant relationship. Single-family homes and multi-unit dwellings are the most common types of investment property, producing passive income for the owner. Like any property you invest in, rental property will require a continued, ongoing stream of reinvestment if it is to be maintained to standard. For this reason, when you invest in real estate for passive income purposes, it’s important to remember that you’ll need to factor in the costs of ongoing improvements and maintenance into the budget so that you can charge your tenants the proper amount of rent.
How do you define a second home?
A second home, also known as a vacation home or secondary residence, is a property that an individual or a family owns and uses for recreational or occasional purposes, usually in addition to their primary residence. It is not the primary dwelling where the individual or family lives on a regular basis. A second home is typically located in a different geographical area from the primary residence and is often used as a getaway for holidays, weekends, or other leisure activities. Many people will buy a second home in a place that they will ultimately retire to in hopes of making a final transition there one day.
The key distinction between a primary residence and a second home is that the primary residence is the main place of living, while the second home is used intermittently for leisure or vacation purposes. Second homes can be used for personal enjoyment, rented out as a source of income when not in use, or a combination of both. The specific regulations and implications of owning a second home can vary depending on local laws, tax regulations, and other factors.
According to the IRS, for a property to be considered a second home for tax purposes, it must be occupied by you for a minimum of 14 days out of the year. This will serve as a vital distinction when it comes to defining a second home versus an investment property.
The key distinction between a primary residence and a second home is that the primary residence is the main place of living, while the second home is used intermittently for leisure or vacation purposes. Second homes can be used for personal enjoyment, rented out as a source of income when not in use, or a combination of both. The specific regulations and implications of owning a second home can vary depending on local laws, tax regulations, and other factors.
According to the IRS, for a property to be considered a second home for tax purposes, it must be occupied by you for a minimum of 14 days out of the year. This will serve as a vital distinction when it comes to defining a second home versus an investment property.
If your new property is legally considered a second home, you can enjoy many of the tax deductions you would ordinarily receive as a homeowner. However, if you fail to occupy the property for the minimum amount of time during the tax year, what you bought for the purpose of having a vacation home will instead be legally considered an investment property.
Could a second home also be used as an investment?
While many people purchase second homes for personal use and enjoyment, they can also be seen as investment opportunities. Here are a few ways in which a second home can be used as an investment:
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Rental Income: Owners of second homes can choose to rent out their property when they are not using it. This can generate rental income that helps offset the costs of owning and maintaining the property. Vacation rentals have become increasingly popular through platforms like Airbnb, VRBO, and others. It’s important to remember that, in order for your property to be classed as a second home, you must reside in it for more than 14 days in the year (or 10% of the days that you rent it out).
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Appreciation: Just like primary residences, second homes have the potential to appreciate in value over time. If the property is located in a desirable area and the real estate market is favorable, the value of the second home is likely to increase, allowing the owner to sell it for a profit in the future.
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Diversification: Owning a second home can be a form of diversification in your investment portfolio. Real estate investments can provide a level of diversification compared to traditional investment assets like stocks and bonds.
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Retirement Planning: Some people purchase a second home with the intention of eventually retiring there. This can provide a comfortable and familiar environment in which to spend their retirement years.
Should you choose to use your legally defined second home to produce income, you should consult with a tax professional before making your next move.
Financing
How you can secure financing for a second home versus an investment property is also different. Financing for a primary home is always the most straightforward to get approval. But if your income-to-debt ratio is solid with a second mortgage factored in, you’ll find that getting financed for that second home isn’t generally prohibitive (although the lending requirements are usually stricter).
Getting financing for an investment property, on the other hand, is more complex. This will require a higher credit score and a much higher down payment, and government-backed loans are typically not available for these endeavors. Consult with your real estate agent if you are considering an investment property. They will be able to put you in contact with a trusted lender who can walk you through the requirements needed for a loan.
Ready to invest?
If you are considering purchasing real estate, whether for a second home or an investment property, your next move should be a consultation with an expert real estate agent. Partner up with the Zaremba Potts Group for top-tier guidance every step of the way. This trusted team has a proven track record of success, and they’re ready to help you achieve all your goals.
*Header photo courtesy of Shutterstock
