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Second Home Exemption And 401K
If you are planning to invest in a second home, you may end up enjoying some of the same basic tax benefits that you currently enjoy owning your own home. This benefit is not in terms of interest and taxes; rather is in the value of the use of the property on a tax free and rent free basis. A second home means that you are not using your money to earn taxable investment income. Instead you are using it for vacation purposes that otherwise you would have ended up paying for with your after-tax income. |
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Let us take an example of a second home in context to tax exemption. If we assume that your second home costs around $50,000, you would be earning approximately $4,500 in tax free money. Assuming that it costs $150 per night to rent a similar vacation home, that vacation home would have to be occupied at least 30 days to generate $4,500. However, a second home can be rented for up to 15 days a year and the income from it would be considered tax free. Therefore, if you use your second home for 15 days and rent it out for 15 days at the rate of $150 a day, you will end up receiving 9 percent yield each year after taxes.
To the extent your second home is financed would result in the interest being deducted similar to the interest on your main home. Even real estate taxes can be deducted if you itemize the deductions. To the extent you rent the second home for more than 15 days per year, the income and expenses can be reported on Schedule E and you also have the liberty of allocating a portion of the income and expenses to that schedule.
You can sell your main residence without paying capital gain taxes for the first $250,000. It is $500,000 for a married couple filing taxes jointly. You do get a tax break but you do not have a place to live and you end up using the home from your home sale on rent. However, if you use your 401k retirement plan to buy a second home, you will end up getting the entire tax benefit while still having a place to live which is not under mortgage.
It is better to buy your second home in a place you wish to live after retirement. Make sure that the location allows you to easily rent the house when you are not living in it. Once you use your 401k to buy a second home, in the next 15 to 20 years the second home will be yours with no mortgage.
A point to remember is that if you are selling your second home, the IRS Code 121 tax break is not applicable as it was not your primary residence. However, you can avoid taxes on the sale of your second home by converting it to a rental property and then make a Starker tax deferred exchange using IRS Code 1031(a)(3).
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