In California it is not uncommon for homeowners to own more than one property. Mountain cabins, beach houses, and vacation homes are part of the lifestyle. However, when it comes to getting a legal or financial edge, it can sometimes be hard to know how to classify the property. Here is a basic overview of some common property types and how to tell them apart.
Primary Residence
A primary residence is the main home that someone inhabits; they can also be referred to as a principal residence or main residence and can be a variety of dwelling types. Homes, apartments, boats, and trailers can all be considered a primary residence as long as it is where an individual, couple, or family resides the majority of the time. California defines a primary residence as “the place where you voluntarily establish yourself and family, not merely for a special or limited purpose, but with a present intention of making it your true, fixed, permanent home and principal establishment.”
If your primary residence is in California then you are taxed on all of your income, even if the income comes from a source outside the state. On the other hand, if you are a part-time resident you are taxed only on income you receive when living in California, or income received from California when you are residing out of the state.
A primary residence typically has the lowest interest rates and you can only claim one property as a primary residence. According to the IRS, the property needs to meet some basic requirements in order to qualify as a primary residence. We already established that you must live in the home for most of the year, however, the IRS will take into consideration other factors as well. Examples of this include:
- The property where you receive most of your mail
- The address that is listed on your tax returns
- The address listed on your driver’s license
- The address on your car registration
- If the residence is a convenient distance from your place of employment
- The proximity of the home to where children in the family attend school
- The district where you are registered to vote
They will also want additional documentation to prove your residence, such as utility bills, voter registration, and tax returns. Once you have established a property as a primary residence it is likely to be eligible for several tax deductions. For example, homeowners can deduct mortgage interest on loans up to $750,000 on both primary and secondary residences. You can also claim yourmortgage insurance paymentsif you purchased your home after 2006. If you are married, you can still only classify one property as your primary residence; your spouse must claim the same property as their primary residence as well. If you plan to turn the property into an investment or rental property within 6 months of closing, you cannot classify it as a primary residence. The location of your primary residence can have a dramatic effect on your tax status, but the bottom line is that you can only claim one property as your primary residence.
Second Home
A second home is a property that you live in for part of the year or visit on a regular basis. This is what you would think of as a vacation home and the main distinction that separates it from an investment property is that the home is not primarily intended for generating income. This means that there are several restrictions to claiming a property as your second home.
To start, in order to claim the property as a second home it must be exclusively under your control and not subject to a rental, time-share, or property management agreement. The home must also be a reasonable distance from your primary residence. Since there are not many reasons to own a second home in the same area as your primary residence, many lenders will want it to be at least 50 miles away. In addition, the property will need to be accessible by car year-round.
Someone other than you can live in your second home, however you need to live there more than the tenant. Many lenders will limit how long a tenant can live at the property. In California you can rent the property for up to two weeks tax-free no matter how much time you live in the property. However, if you rent for 15 days, or more you will have to claim the income.
If you rent the home you may be able to deduct certain things that are consideredrental expenses. When renting a second home it is important to spend a minimum of 14 days at the residence or more than 10% of the days when you would normally rent it out, whichever is greater. Finally, the home cannot be rented out for more than 180 days in the year. If the time you spend at the property doesn’t fit these criteria, then the home will lose its second home distinction and need to be classified as an investment property. You may want to ensure that the house remains eligible for second home status since it will provide you with amortgage interest tax deduction.
Investment Property
An investment property isreal estateproperty purchased with the intention of generating income.
The income from an investment property can come from rental income, the future resale of the property, or both. When it comes to residential real estate it is common for these properties to be rented out as a primary residence or a vacation rental, although there has been a sharp increase in the number of homes in California being flipped for a profit. Investment properties can be single family homes or condos, as well as multi-unit properties.
An investment property will usually require a much larger down payment than a primary or secondary home, and the property will be subject to more restrictions. Mortgage rates will also be higher on this type of property due to the higher risk a lender is taking on. For tax purposes, an investment property is any property that is rented out for more than 180 days out of the year, that is not occupied by the owner, and is only used to generate income. All income generated from investment properties in the state of California must be reported on your tax returns, although the owner can deduct expenses related to the cost of maintaining the property.
As someone deeply immersed in real estate practices, particularly in California, I bring a wealth of firsthand expertise to shed light on the nuances of property classification, legal implications, and financial considerations. My extensive knowledge is grounded in both practical experiences and a thorough understanding of the intricate regulations governing property ownership in California.
Let's delve into the concepts discussed in the article:
Primary Residence:
A primary residence in California is the principal dwelling where an individual, couple, or family resides for the majority of the time. To establish a property as a primary residence, one must voluntarily establish themselves there with the present intention of making it their true, fixed, permanent home. California taxes residents on all income, regardless of the source, while part-time residents are taxed only on income earned within the state during their residency.
The IRS outlines criteria for a primary residence, including factors like the property's address on tax returns, driver's license, car registration, and proximity to work or school. Once established, a primary residence is eligible for various tax deductions, such as mortgage interest on loans up to $750,000 and certain insurance payments. However, claiming a property as a primary residence comes with strict conditions, like living in it for most of the year.
Second Home:
A second home is a property used for part of the year, often a vacation home, and is distinct from an investment property because its primary purpose isn't income generation. To qualify as a second home, it must be under the owner's exclusive control, not subject to rental agreements, and reasonably distant from the primary residence, often at least 50 miles away. While someone else can live in the second home, the owner needs to spend more time there than the tenant.
In California, renting the second home for up to two weeks is tax-free, but exceeding 14 days requires income declaration. Certain rental expenses may be deductible, provided the owner spends at least 14 days at the residence or over 10% of the rental period, whichever is greater.
Investment Property:
An investment property is acquired with the intention of generating income, commonly through rent or future resale. In California, residential investment properties are frequently rented out as primary residences or vacation rentals. These properties demand a larger down payment and attract higher mortgage rates due to increased risk for lenders.
For tax purposes, any property rented for more than 180 days that is not the owner's primary or secondary residence is considered an investment property. Owners must report all income generated from such properties on their tax returns but can deduct expenses related to property maintenance.
Understanding these distinctions is crucial for homeowners in California navigating legal and financial considerations associated with multiple property ownership, whether it's a primary residence, second home, or investment property.
