Updated: Sep 27
If it’s financially feasible for you, owning a second property can be an excellent investment. You can use the property as a vacation rental, or retain it for your own vacation purposes and hold it to use as a primary home during retirement.
However, before you jump on that cute fixer-upper you spotted, it’s worth pausing to assess your risks. Owning any home carries a significant financial burden—from mortgage and taxes to maintenance and repairs. For that reason, it’s in your best interest to make sure the investment is the right one for you.
There are many considerations to make before becoming a second-home owner. This article by no means covers them all. Instead, consider it a good primer to begin a conversation with your EXP real estate agent.
First, What is an Investment Property?
Second homes. Vacation homes. Investment properties. To the average homebuyer, these terms may feel interchangeable, but to the IRS and your mortgage lender, they mean very specific things:
Primary Residence – The main residence or dwelling in which a person lives—usually a house or apartment, but could include a houseboat or house trailer—that is considered their legal residence for the purposes of declaring income tax or acquiring a mortgage. A person can have only one primary residence at a given time, though they may share it with other people.
Second Home – A residence that a person occupies for part of the year in addition to a primary residence. Typically, a second home is used as a vacation home, though it could also be a property visited on a regular basis, such as a condo in a city where a person regularly conducts business.
Investment Property – A property that (1) is not your primary residence, and (2) is “purchased or used in order to generate income, profit from appreciation, or to take advantage of certain tax benefits.” This can include residential rental property, commercial property, and property purchased to “flip” for a profit.
Pros and Cons of Buying a Second Home
Second homes sound lovely in theory, but it’s important to review your short-term and long-term finances closely before purchasing. According to Investopedia, “Keeping a second home is a step up in magnitude [from your first home] because a second home has all the costs (often more) of your first home without the easy write-offs from the IRS.”
Many lenders are wary of making second-home loans and require the property to be a certain distance from your primary residence or located in a resort or vacation area (e.g., near the mountains or ocean). They usually include a Second Home Rider along with the mortgage that states that you, the borrower, will not use the property as a rental, timeshare, or for other profit. However, second-home loans do regularly have a lower interest rate than investment property loans.
Before you buy, consider the added costs associated with local taxes, HOA fees, and any property management or regular maintenance. Keep in mind that many lenders require that your second home be a minimum of 50 miles from your primary residence. This can make even small repairs challenging to take care of quickly unless you have systems in place.
As long as you follow your lender’s rules and use the property exclusively as your second home (and not a rental), there are some tax benefits. You can deduct mortgage interest similarly to how you would for your primary residence, up to a total of $1.1 million in value between the two homes. Property taxes may also be deductible as well, but contact your real estate tax specialist for current information relevant to your investments.
Pros and Cons of Buying an Investment Property
Because of lenders’ Second Home Riders and other restrictions from the IRS, it’s difficult to turn an existing second home into a profit-making investment property. If you intend to develop an investment property, you should go into loan agreements with that express purpose in mind.
No matter how shiny and great your investment property is when you open it to the public, repairs will come up. Be sure you can include those costs in the price of the rental, while remaining competitive. If there are HOA fees or other property maintenance costs, consider the inflation to those year after year, as well. We’ve never heard of vendors wanting less money upon a contract renewal.
It’s often not considered up front, but it’s important to know that annual returns on investment properties can be negative. Major home repairs to a regular rental or a down year in tourism can impact your bottom line in a big way. Consider the overall health of the rental market in your area, and whether a single natural disaster or downturn in the market will affect traffic to your area, and thus your rental. It’s important that you are personally able to cover the cost of the second mortgage and utilities of the second property, even if no one is in it for a while.
Just like your primary home, investment properties may not alway appreciate in value and are subject to a sometimes fickle rental market. For that and other reasons, investment property loans usually have higher interest rates and require a larger down payment than second home properties.
How do Investment Properties Affect Your Taxes?
The income you earn from an official rental property is subject to federal taxes. However, the IRS says you can deduct various costs related to a rental home, including repairs, utilities, advertising, taxes, insurance, maintenance, and more—but those deductions depend on how many days you spend in the house per year. The home must be rented more than 15 days per year, and you may only use the home yourself for 14 days or 10 percent of the number of days you rent the home (whichever is greater). The intricacies of the tax code are worth considering before you make your investment purchase. Ask your real estate tax specialist for more information.
Second Homes vs. Investment Properties: The Bottom Line
Lenders have different rules and rates for second homes as compared to investment properties. The IRS offers different benefits and requires different taxes for each. These rules and more will affect your wallet directly when making your purchase, so it’s good to understand the intricacies of each property up front.
Discuss your goals with your EXP agent and mortgage lender. If this is your first time purchasing a second property, they will be able to help you weigh the short- and long-term benefits of either decision.
All real estate is local. In order to make confident real estate decisions, we believe it is important for you to have timely and neighborhood-specific information. If you would like more information about buying a home in NC, our experts at EXP Realty are here to help. Contact us today to speak with a EXP agent about buying homes or land in North Carolina.