Second Home

A second home is a dwelling an owner keeps in addition to a main residence. Beyond that, the phrase carries no single definition, and the practical difficulty for owners is that the rulebook asking the question changes the answer. The Internal Revenue Service defines it by election, mortgage underwriting defines it by occupancy and use restrictions, and FHA does not use the term at all.

Publication 936 is the most permissive of them and states its rule in one sentence: "A second home is a home that you choose to treat as your second home." A home for this purpose "includes a house, condominium, cooperative, mobile home, house trailer, boat, or similar property that has sleeping, cooking, and toilet facilities," and a taxpayer "can have only one main home at any one time." Where an owner has more than one candidate, only one may be treated as the qualified second home in a year, though the publication allows the choice to be changed during the year in stated circumstances, such as acquiring a new home or selling the existing second home.

The tax rule has two branches, and the unrented branch surprises people. Publication 936 says that if you have a second home "that you don't hold out for rent or resale to others at any time during the year, you can treat it as a qualified home," and adds: "You don't have to use the home during the year." A cabin sitting empty for twelve months is a qualified second home. The other branch applies when the property is rented out: "If you have a second home and rent it out part of the year, you must also use it as a home during the year for it to be a qualified home. You must use this home more than 14 days or more than 10% of the number of days during the year that the home is rented at a fair rental, whichever is longer. If you don't use the home long enough, it is considered rental property and not a second home." Note that the days threshold is the longer of the two, so more renting demands more personal use, not less. And the publication expressly extends the category to time-sharing arrangements: a home owned under a time-sharing plan can be a qualified home if it meets all the requirements.

Mortgage underwriting defines a second home almost as the opposite. Fannie Mae's Selling Guide sets out an occupancy class with hard requirements: the property "must be occupied by the borrower for some portion of the year," "is restricted to one-unit dwellings," "must be suitable for year-round occupancy," the borrower "must have exclusive control over the property," it "must not be rental property or a timeshare arrangement," and it "cannot be subject to any agreements that give a management firm control over the occupancy of the property." A footnote softens one edge: where the lender identifies rental income from the property, the loan can still be delivered as a second home provided the income is not used for qualifying and every other requirement, including occupancy, is met.

Which produces a genuine contradiction between the two rulebooks. The tax rule lets a property be rented substantially and stay a second home, so long as personal use clears the 14-day or 10 percent threshold, and lets a timeshare be a qualified home. The mortgage rule requires occupancy in the year, forbids rental property, forbids a timeshare, forbids more than one unit and forbids a management agreement over occupancy. So the same lake house, in the same year, can be a second home for the mortgage interest deduction and not a second home for the loan that financed it. Nobody is wrong; the two systems are asking different questions, one about how the property is used for tax purposes and the other about how the collateral will behave. An owner planning to rent a second property should assume the classification the lender applied at closing is not the classification the return will use.

FHA is a third vocabulary, and none of its words is "second home." Under 24 CFR 203.18(f), a "principal residence" is the dwelling where the mortgagor maintains a permanent place of abode and typically spends the majority of the calendar year, and "a person may have only one principal residence at any one time." The regulation's other category is a "secondary residence," defined as a dwelling where the mortgagor maintains a part-time abode for less than a majority of the year, "which is not a vacation home," and which the Commissioner has determined to be eligible for insurance "in order to avoid undue hardship to the mortgagor." One at a time. That is a narrow hardship provision rather than a category for a vacation property, and reading it as the FHA equivalent of a second home inverts it.

The fourth rulebook is the one that applies when you sell. The exclusion of gain on the sale of a home is available for a principal residence meeting its ownership and use tests, and a second home is precisely the property that does not qualify for it. Gain on the sale of a second home is generally taxable in full. Interest is the other place the two properties are treated alike rather than separately: a qualified second home's mortgage interest counts against the same acquisition-debt limit as the main home rather than getting a fresh one.

In practice the classification is settled twice: once at the closing table by the lender, on the borrower's stated intent and the loan program's rules, and again each year on the tax return, on how the property was actually used. Nothing links the two determinations, which is why they can diverge.

A hypothetical example of the divergence. The Ochoas own a cabin they financed as a second home. In one year they rent it at a fair rental for 200 days and use it themselves for 26 days.

For the mortgage interest deduction, the test is more than 14 days or more than 10 percent of the rented days, whichever is longer. Ten percent of 200 days is 20 days, and 20 is longer than 14, so they must use it more than 20 days. They used it 26, so the cabin remains a qualified second home and the interest remains qualified residence interest, counting against the same acquisition-debt limit as their main home.

For the loan, the same facts are a problem. A property rented at a fair rental for 200 days is rental property, and the second-home occupancy class requires that the property not be rental property. Had they used it 18 days instead of 26, the tax answer would flip too: below the threshold the cabin is considered rental property and not a second home for the deduction, and a different set of rules governs the deductions altogether.

Pros

• Mortgage interest on a qualified second home is deductible as qualified residence interest, subject to the shared limit.
• Second-home financing is generally priced better and requires less down than investment-property financing on the same property.
• The tax definition is generous where the property is not rented out: no minimum personal use is required at all if it is never held out for rent.
• A property that fails the second-home tests is not disqualified from everything; it becomes rental property, with its own deductions.

Cons

• The interest counts against the same acquisition-debt limit as the main home rather than a separate one, so a second mortgage can crowd out the first.
• Only one property can be the qualified second home in a year, however many are owned.
• The tax and mortgage definitions genuinely conflict once the property is rented, and satisfying one can breach the other.
• The exclusion of gain on sale does not reach a second home, so appreciation is generally taxable in full.
• Representing occupancy to a lender that the actual use will not match is a misrepresentation to the lender, not a technicality.