29 Apr If I Occupy my Own Property, Does it Count as an Investment?
Depending on the type of property and perhaps the length of time you’re using it, it could count as an investment property.
You’ve probably heard the phrase, “Your home is your biggest investment.” In one sense, that’s true since many people spend more money on their personal residence than on other things. If you give it time, your home should appreciate in value. Some investors even buy a fixer-upper, live there for two or more years, and then sell their house for a profit. If you sell a house that you lived in at least two of the past five years, then the first $250,000 of capital gains is tax-free ($500,000 if married, filing jointly). That’s what I call a slow flip.
From a cash flow standpoint, your own home is not an investment. You’re spending money to live there instead of receiving money. Sure, there is an economic benefit from not having to pay rent somewhere else, yet your own home is still taking money out of your bank account.
One way your home could put money in your bank account is by a loan to extract some of the equity. Ideally, you would take that cash and buy an investment property that produces more income than the cost of the interest.
If you buy a 2-4 family property and live in one unit while renting the rest, you technically have an investment property. For tax purposes, the IRS treats the unit you live in as if it were a totally separate property. Deductible expenses for the unit you live in are reported on Schedule A of your tax return, whereas the leased unit(s) are reported on your Schedule E. There can be some valuable tax deductions in such a case. You are allowed to deduct any dual use expenses that benefit all the units. Let’s say you pay for a garbage fee and for an alarm system subscription for the entire property. You can fully deduct both expenses.
A second home is defined as a one-unit property that you live in at least some of the year. If you own a second home and rent it when you’re not there, in one sense you can call it an investment property and in another sense it’s not. If you’re defining an investment property simply as something that puts money in your pocket, then it would be one. The IRS tax code holds that in order for you to count a property as a second home, you must reside in it at least 14 days a year or at least 10% of the total days that it is rented in a year.
When it comes to tax deductions, a second home is treated differently than a non-owner occupied investment property. With an investment property, the IRS allows you to deduct maintenance costs, utilities, and depreciation. With a second home, just like your principal residence, you cannot count those as deductions.
When it comes to financing, a loan for a second home usually involves a lower interest rate, smaller down payment, and fewer fees than a loan for a non-owner occupied property. If you receive a second home type of loan, you must occupy the property at least some of the time in accordance with the lender’s rules. You don’t want to obtain a loan under the pretense that you’re buying a second home when in reality you’re planning to use it as an investment the entire year.
A principal residence or second home could be turned into an investment property when you stop living there. My first home was a fixer-upper duplex. For three years, I lived there while leasing the other unit. Then I moved out and rented both units. After 17 years of owning the property, I sold it. Because it was an investment property, I was able to defer my capital gains taxes by using an IRS tax code 1031 exchange in the purchase of another rental property.
Consult your tax advisor regarding your own situation. I hope you have plenty to talk about with your accountant, from your primary residence to your second home to your many investment properties!
Tai DeSa is a graduate of The Wharton School of the University of Pennsylvania. He became a full-time real estate investor in 2004 after serving in the U.S. Navy. Tai made colossal mistakes in investing (and learned some things along the way). Tai has coached hundreds of entrepreneurs, real estate investors, and real estate agents on how to increase their income and net worth. He has helped hundreds of homeowners avoid foreclosure through successful short sales. Check out Tai’s books on Amazon.com. Tai may be available for coaching and speaking engagements on a variety of real estate topics. Send an email to tai@investandtransform.com.
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