Second Home or Investment Property? It's both, but...

8 Replies

I know there's reason for hesitancy when renting to family, but hear me out. There are some decent priced properties that allow me to make the numbers work back in my hometown. I am looking to purchase a property and allow my mother to rent it from me, yet it will also be a second home for when I visit (which is fairly frequently). I have two questions: From a loan standpoint, what is the better option? An investment property or second home?

My next question is from a tax standpoint....which one is more beneficial for tax purposes or is there a "right" way when it comes to this situation? Are there differences in insurance prices as well? Any insight would be appreciated. The best option that makes my money work for me is the ideal option of course, but I want to make sure my choices are legal and lessen my chances of being audited. Thanks!

@Jacqueline Brown

When you rent it, are you renting it at a "market" rate or less than market rates?

@Dawn Anastasi, I'll be renting it for below market as long as she lives there. 

It has to be rented at market rate if you have it as a rental to really be considered an investment.  If you rent it more then two weeks a year and use it as a second home ask your tax guy but my experience is that is mixed use. Mixed use you would deduct a percentage of the houses expenses (based on the percent you rent) against the income you make on that rental. That percentage is whatever percent of the house that is rented to look at it in a simple fashion.  Time you use it figures in.  If you are renting to your mom as a roommate at a rate that is similar to the room and use of the common areas the percentage that is hers is what would be considered the rental portion.  It still has to be fair market value for what you are renting.

If you are renting a whole house at market rate to your mother you are probably ok to have it as an investment even if you do visit but keep excellent records.   Sounds like you are not doing that.

Investment is  different in terms of insurance and mortgage. A rental has the possibility of deductions but much of that can be limited based on your income and assuming real estate is not your occupation.  Second home is probably better interest on your mortgage and a homeowners policy.  One caveat is if you ever intend to move back in with your mom the transition from investment to second home once the house is depreciated can get more complex. It sounds like you would have a second home or mixed use but it would be worth it to ask the tax guy so you do it right to begin with. 

@Colleen F., I've just put in an offer so there isn't much in the way of paperwork just yet. I was mainly concerned with what can constitute a second home since I am renting it to my mother but I will be staying there when I visit her. She'll be paying me below market rent, but I was concerned with how things may get convoluted come tax time. Thanks for the responses!

Since you are renting to a relative below market rent, your rental expense deduction may be limited to the amount of rental income received.  Consult your CPA for specific details.

It is good you are thinking about it pro-actively.   Mortgage wise I would favor having it as a second home, the mortgage company will likely be fine with it.  If you will visit a lot and you are worried about having a second home rented  you could structure the rent for your mom as room plus use of common areas or shared expenses rather then leasing the house per se.  Even though it is helpful to ask here a good CPA will keep you out of trouble with the deductions.  Good luck with the purchase.

Some typical second home thoughts:

Is it located a reasonable distance away from the borrower's principal residence?

Will it be occupied by the borrower for some portion of the year?

Is it suitable for year-round occupancy?

It can't be under a rental property or a timeshare arrangement.

Typically the lender will want to see that it is located in a resort or vacation type location.

I think the biggest problem for you will be proximity to your principal residence. Typically second home mortgage rates are a half point lower than investment property loans.

Good luck!

As long as you are renting it below market you are going to have issues. Mortgage broker for approval will be important. The issue is investment is 20% down and second home is 10% down. Investment is also a high interest rate than second home.

Since you are mixing family with investments I recommend you find a GREAT CPA and a lawyer

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